HBB 


mim.  I 


i 


EXCHANGE 


PRINTED  FOR  THE  USE  OF  STUDENTS  IN  THE 
UNIVERSITY  OF  MICHIGAN 


PRINCIPLES  OF  ECONOMICS 


BY 

F.  M.  TAYLOR,   PH.  D, 


-SECOND  EDITION 


ANN  ARBOR 

UNIVERSITY  OF  MICHIGAN 
.  1913 


COPYRIGHTED  BY  F.  M.  TAYLOR, 
1911    1913 


PREFACE  TO  THE  FIRST  EDITION 

As  indicated  on  the  title  page,  this  book  is  printed  for  the  use 
of  students  in  the  University  of  Michigan.*  Numerous  defects, 
which  are  of  little  importance,  while  it  is  in  the  hands  of  teachers 
who  have  more  or  less  shared  in  its  preparation,  quite  unfit  it  for 
use  by  others. 

The  book  is  copyrighted;  but  any  teacher  is  at  liberty  to 
reprint  any  portion  which  he  may  consider  useful  for  his  pur- 
poses. 

*  It  is  not  sent  out  for  review. 


293266 


PREFACE  TO  THE  SECOND  EDITION. 

The  principal  changes  in  this  edition  consist  of  an  almost  com- 
plete rewriting  of  Chapters  8  and  9, — the  latter  having  been 
divided  into  Chapters  9  and  10.  This  rewriting  was  more 
complete  in  the  case  of  the  former;  but  the  latter  was  very 
considerably  changed.  The  failure  to  revise  Chapters  12  and  13 
(now  13  and  14)  on  the  basis  of  the  rewriting  of  8  and  9  gives 
rise  to  some  inconsistencies ;  but  all  or  nearly  all  of  these  are 
formal  rather  than  material.  I  have  been  much  disappointed  at 
not  having  finished  a  thorough  revision  of  Chapter  13  (now  14)  ; 
but  it  proved  quite  impossible  to  do  so.  I  hope  to  have  such  a 
revision  ready  for  next  year's  edition.  Besides  the  above,  the 
most  important  change  is  the  remodelling  of  some  pages  in 
Chapter  4.  A  good  many  lines  have  been  reset  in  order  to  elim- 
inate minor  errors. 


IV. 


CONTENTS. 

i  XTKOPUCTTON     1-7 


CHAPTER  I. — PRELIMINARY  ACCOUNT  OF  THE  EXISTING  ECONOMIC 

ORDER. 

The  dominant  features  of  the  present  economic  order,  9-14: 
Principal  advantages  of  co-operation  looked  at  from  the  stand- 
point of  individuals,  14-15;  Some  formal  principles  -based  on  the 
above  general  account  of  the  present  economic  order,  15-24;  Some 
necessary  le-gal  conditions  of  the  present  economic  order,  24;  In- 
terference with  the  free  automatic  regulation  of  economic  action 
in  the  interest  of  the  group  welfare,  25-28;  Interference  with  the 
automatic  regulation  of  economic  action  which  is  intended  to 
promote  a  different  distribution  of  income,  28-30.  9-30 


CHAPTER   II. — ANALYSIS   OF   PRODUCTION. 

Surface  account  of  the  elements  or  factors  involved  in  com- 
modity production,  31-33;  The  factors  of  production  revised  and 
grouped  on  the  basis  of  a  deeper  analysis,  33-37;  Should  the  fac- 
tors of  production  be  reduced  to  two  or  one?,  37-40;  Relations 
of  the  several  factors  of  production  to  one  another,  40-42;  The 
agents  in  production,  42-46;  Utility  costs  and  disability  costs, 
46-48;  Kinds  of  disutility  costs,  48-51;  Utility  costs,  51;  Money 
costs,  51-53;  The  enterpreteur's  cost,  53-55;  The  word  pro- 
duction used  in  different  senses,  55-56;  Broad  meaning  of  produce- 
55-60;  Narrow  meaning  of  production,  61-62;  Special  function 
of  capital  and  the  capitalist,  62-64;  Is  capital  productive?,  64-67; 
Different  kinds  or  forms  of  capital,  67-70.  \^~  31-70 


CHAPTER  III. — THE  CONDITIONS  AND  LAWS  OF  PRODUCTIVE 
EFFICIENCY. 

Capitalistic  methods,  71-72;  Specialized  or  heterogeneous  co- 
operation, 72-78;  Large-scale  production,  78-80;  Industrial  free- 
dom, 80-82;  Integration  of  industries,  82;  The  Unification  of 
industries:  Consolidation,  Combination,  82-84;  Efficiency  in  re- 
spect to  the  entrepreneur  function,  85-86;  Efficiency  in  re- 
the  capitalistic  function,  86-92 ;  The  efficiency  of  labor,  92-93. 

71-93 

v. 


PRINCIPLES  OF  ECONOMICS 

CHAPTER  IV. — COMBINING  PROPORTIONS  AND  PRODUCT. 

Production  processes  are  joint  processes,  94-95;  Principles 
governing  the  combining  of  individual  divisible  factors,  95-110; 
Principles  governing  combination  with  one  factor  indivisible,  no 
113;  Heterogeneous  combinations,  113-116;  The  efficiency  of  in« 
dustries  as  wholes  in  relation  to  size  of  output,  116-122;  The  effi- 
ciency of  countries  as  wholes  in  relation  to  volume  of  output, 
122-127.  94-I2/ 


CHAPTER  V. — THE  MECHANISM  OF  EXCHANGE. 

Money  exchange,  128-131;  Analysis  of  credit  exchange,  134; 
Instruments  of  credit  exchange,  135-136;  The  rate  of  exchange, 
136-137;  The  commercial  bank,  137-140.  128-140 


CHAPTER  VI. — SOME  ELEMENTARY  PROPOSITIONS  WITH  RESPECT  TO 

MONEY. 

Money  as  a  form  of  wealth,  141 ;  Money  as  a  form  of  capital, 
141-142;  The  quantity  of  money  needed,  142-143;  The  nature  of 
money  to  circulate,  143;  The  nature  of  money  to  remain  money, 
141-142;  The  quality  of  money  needed,  142-143;  The  nature  of 


CHAPTER  VII. — CERTAIN  FUNDAMENTAL  PRINCIPLES  OE  TRADE. 

Say's  Law  :  The  ultimate  identity  of  demand  and  product,  147- 
151;  Statement  of  the  principle  of  reciprocity,  151-152;  Invisible 
imports  and  exports,  152-153;  Argument  for  the  principles  of  rec- 
iprocity, 153-157-  147-161 


CHAPTER  VIII. — THE  PRINCIPLES  GOVERNING  THE  IMMEDIATE 
DETERMINATION  OE  PRICES. 

The  problem  of  price  determination,  162-164;  The  nature  of 
demand,  164-166;  The  relation  of  demand  to  price,  166-170;  The 
interpretation  of  demand  scehdules,  170-177;  The  nature  of  sup- 
ply, 177-178;  The  relation  of  supply  to  price,  178-183;  The  inter- 
pretation of  supply  schedules,  183-189;  The  law  of  single  price, 
189-190;  The  law  of  supply  and  demand  with  typical  schedules, 
190-201 ;  The  law  of  supply  and  demand  with  irregular  schedules, 
201-205 ;  The  law  of  supply  and  demand  with  a  one-price  supply 
schedule,  205-209;  The  relation  of  actual  prices  to  demand  and 
supply  prices,  209-213;  Case  I,  with  constant  supply  and  typical 
demand  schedules,  213-215;  Case  II,  with  constant  demand  and 
typical  supply  schedules,  215-218;  Case  III,  with  schedules  of  the 
type  showing  a  single  supply  price,  218-220;  Case  IV,  with  typical 
demand  and  supply  schedules,  220-221.  162-221 

vi. 


CONTENTS. 

CHAPTER  IX. — NORMAL  PRICE. 

Definition  of  normal  price,  202-203;  Normal  price  and  the 
law  of  supply  and  demand,  223-224;  The  classification  of  commod- 
ities from  the  standpooint  of  normal  price,  224-230;  Normal  sup- 
ply schedules,  230-233;  Normal  demand  schedules,  233-236;  The*, 
law  of  diminishing  marginal  utility,  236-238;  Demand  prices  ex-j 
pressions  of  marginal  signficances,  238-241 ;  Normal  pries  of  fixed 
supply  goods,  242-246;  Normal  price  of  constant-cost  goods,  246- 
253;  Normal  price  of  increasing-cost  goods,  254-259;  Joint-cost 
products,  260-262;  Diminishing-cost  goods,  262-263;  Fixed-supply 
income-bearers,  263-266;  Normal  price  under  monopoly,  266-269; 
Miscellaneous  problems  in  price,  269-271.  202-271 


CHAPTER  X. — THE  FINAL  THEORY  OE  PRICE-DETERMINATION. 
SUPPLEMENTAL  TOPICS. 

The  statement  of  the  problem  of  price-determination,  272-275 ; 
The  first  approximation,  275-281 ;  The  second  approximation, 
281-287  >  The  third  approximation,  287-294 ;  The  fourth  approxi- 
mation, 294-296;  The  formula  for  fiinal  price-determination  under 
actual  conditions,  297-301 ;  Statement  of  the  labor  theory  of  value, 
301-303;  Refutation  of  the  la'bor  theory  of  value,  303-306.  272-3:6 

CHAPTER  XI. — SOME   SPECIAL   CASES  OF   PRODUCTION. 

The  productivity  of  insurance,  307-309;  Produce  speculative 
trading,  310-312;  Speculative  trading  in  stocks  and  bonds,  312-313. 

307-315 


CHAPTER  XII. — SOME  OE  THE  MORE  IMPORTANT  PRINCIPLES 
GOVERNING  MONEY. 

Principles  governing  the  money  standard,  314-318;  Circulation 
of  money,  319-322;  Movements  and  distribution  of  money,  322- 
327;  The  value  of  money,327-333 ;  Miscellaneous  problems  under 
•noney,  333-335-  314-335 

CHAPTER  XIII. — THE  PRESENT  SYSTEM  OF  DISTRIBUTION.        X 

The  principle  sources  and  kinds  of  incomes,  336-338;  The 
influence  of  legal  arrangements  on  distribution,  338-339;  General 
character  of  the  process  whereby  the  regular  economic  shares  are 
determined,  339-340;  The  general  principles  determining  the  reg- 
ular economic  incomes  under  free  competition,  340-345 ;  Corollar- 
ies of  the  productivity  principle,  345-355;  Employment  and  the 
demand  of  goods,  355-357;  Employment  as  dependent  upon  the 
supply  of  land  and  capital,  357-358;  The  limits  of  possible  employ- 


PRINCIPLES. OF  ECONOMICS 

ment,  359-360;  Employment  as  affected  by  the  rivalry  of  capital, 
360-363;  The  interest  phenomenon,  363-365;  Essential  nature  of 
the  interest  phenomenon,  365-366;  Are  capital-services  product- 
ive?, 366-369;  Does  the  return  to  capital  submit  itself  to  the  pro- 
ductivity of  service-value  principle?,  369-3/2;  The  rate  of  interest 
and  the  quantity  of  money,  372-374;  The  rate  of  interest  and 
risk,  374-3/5;  The  nature  of  profits,  375-377;  The  kinds  of  profits. 
377-379 ;  Do  profits  submit  to  the  productivity  or  service-value 
principle,  3/9-382;  Do  profits  submit  to  the  disutility  principle?, 
382-383 ;  Do  profits  tend  to  disappear,  383-385 ;  Special  considera- 
tion of  rent,  385-388;  Income  as  affected  by  prices,  388-389;  In- 
come as  affected  by  taxation,  389-390;  Effective  or  consumptional 
income  as  contrasted  with  absolute  income.  390-391  ;  Incomes  as 
affected  by  non-economic  forces,  391-392;  The  system  under  which 
possessions  are  distributed,  392-395.  336-395 


CHAPTER  XIV. — A  CRITIQUE  OF  THE  EXISTING  ECONOMIC  ORDER. 

The  competency  of  economists  to  pass  judgments  upon  the 
existing  system,,  396-398;  The  present  order  and  production,  398- 
402;  The  present  order  and  consumtpion,  402-404;  The  nature  of 
the  distributive  principle  supposed  to  be  embodied  in  the  present 
order,  404-4^6;  The  communistic  principle,  406;  The  principle  of 
equality,  406-411;  The  labor  productivity  principle,  411-412;  The 
social  service  ideal,  412-413 ;  Argument  for  the  service-value 
principle,  413-417;  The  legitimacy  of  interest,  supposing  the  state 
to  be  the  sole  capitalist,  417-421;  The  legitimacy  of  profits,  sup- 
posing the  state  to  be  the  sole  entrepeneur,  421-422 ;  The  legitima- 
cy of  rent,  supposing  the  state  to  be  the  sole  landlord.  422-423 ; 
The  legitimacy  .of  private  interest,  abstractly  considered,  423-427 ; 
The  legitimacy  of  private  profits,  427;  The  Maxian  theory  of 
profits  and  interest,  427-430;  The  legitimacy  of  private  rent,  430- 
436;  The  efficiency  of  the  regulative  mechanism  supplied  by  the 
laws  of  price,  436-438.  396-441 


FINAL    REVIEW    443-457 

APPENDIX  I. — MISCELLANEOUS  PROBLEMS   459-467 

APPENDIX  II. — EXPLANATORY  NOTES 468-473 

APPENDIX  III. — VARIATIONS  OE  CASES   474-476 


viii. 


PRINCIPLES  OF  ECONOMICS 


INTRODUCTION. 

It  is  a  commonplace  of  which  we  need  only  to  be  reminded 
that  one  of  the  most  characteristic  marks  of  a  sentient  being 
like  man  is  to  have  wants, — we  might  almost  say  that  to  feel 
wants  and  secure  their  satisfaction  is  the  very  essence  of  living. 
It  is  hardly  less  a  commonplace  that  the  great  majority  of  our 
wants  depend  for  their  satisfaction  on  our  disposal  over  certain 
material  objects  or  conditions — material  goods.  Hunger  can  be 
satisfied  only  by  material  food,  the  need  for  shelter  only  by 
material  houses,  the  desire  for  pleasure-riding  only  by  material 
vehicles,  and  so  on.  There  are,  of  course,  some  wants,  such  as 
the  craving  for  affection  from  our  fellows,  or  the  religious 
longings,  which  depend  on  psychological,  or  anyhow  some  sort 
of  immaterial,  conditions.  But  these  are  comparatively  few; 
and  even  they  are  very  closely  tangled  up  with  material  things. 

But  not  only  is  the  satisfaction  of  our  wants  dependent  on 
material  goods,  it  is  further  true  that  most  of  these  material 
goods  are  obtainable  only  in  excliange  for  something, — some 
other  good  relinquished  or  labor  or  other  form  of  sacrifice 
supplied.  In  ordinary  language  they  are  said  to  cost  something; 
the  economist  commonly  expresses  thexsame  fact  by  saying  that 
they  have  exchange  value — they  command  a  price.  Such  goods 
are  designated  generically  wealth.  They  are  also  called  econom- 
ic goods  in  contrast  with  free  goods,  such  as  air  and  sunlight, 
which  are  commonly  obtainable  without  any  cost. 

It  is  a  fact  obvious  to  every  one  that  wealth  is  a  thing  which 
absorbs  a  very  large  amount  of  our  time,  thought,  and  effort. 
We  are  producing  or  consuming  some  of  it  almost  all  day  long. 
Exchanging  it  is  also  a  conspicuous  phenomenon  of  every  day 
life.  Further,  a  considerable  part  of  our  effort  is  given  to 
preserving  it  from  loss  or  deterioration.  Again,  our  sentiments 
toward  wealth  are  notable  facts  of  our  psychic  experience.  In 
particular,  we  prize  it,  attach  a  significance  to  it,  have  a  conscious 
realization  of  its  importance  to  us, — a  fact  expressed  by  saying 
that  wealth  has  individual  or  subjective  value.  All  these  and 
many  other  facts,  happenings,  relations,  connected  with  wealth 
or  economic  goods,  we  call  economic  phenomena.  These 


OF  ECONOMICS 

phenomena  constitute  the  subject  matter  of  Political  Economy  or 
Economics,  just  as  another  set  of  phenomena  constitute  the  sub- 
ject matter  of  Chemistry,  another  set  the  subject  matter  of 
Physics,  and  so  on. 

The  preceding  paragraph  brought  us  to  something  like  a 
definition  of  economic  phenomena.  That  definition,  however, 
would  need  considerable  limitation.  Not  all  the  facts,  relations, 
and  happenings  connected  with  wealth  can  properly  be  included 
under  economic  phenomena.  On  the  contrary,  much  the  larger 
part  of  them  belong,  in  accepted  usage,  to  other  sciences.  For 
example,  wheat  is  of  course  wealth  and  gives  rise  to  many 
phenomena  which  are  strictly  economic.  But  it  also  gives  rise 
to  phenomena  which  are  physical,  chemical,  botanical,  agricul- 
tural, and  so  on.  In  short,  things  are  economic  only  as  looked 
at  in  one  special,  narrow,  way.  In  the  very  strictest  sense,  they 
are  economic  only  when  viewed  as  possessing  value.  However, 
such  strict  limitation  of  our  field  as  this  is  impracticable.  First, 
there  are  certain  very  general  phases  of  the  technological  side 
of  wealth  which  would  naturally  be  treated  only  in  some  science 
having  a  more  general  character  than  such  industrial  sciences  as 
agriculture,  mining,  manufacture,  and  so  on ;  and,  up  to  the 
present,  political  economy  has  been  this  general  science.  Second- 
ly, a  fair  knowledge  of  these  technological  matters,  as  viewed 
from  the  economic  standpoint,  is  absolutely  essential  to  an  intel- 
ligent study  of  the  most  important  of  the  strictly  economic 
problems.  In  fact,  we  shall  find  it  necessary,  as  the  students  of 
other  sciences  do,  to  permit  ourselves  considerable  latitude  in 
the  use  of  this  and  other  terms.  "Economic"  will  sometimes 
include  almost  everything  connected  with  wealth.  At  other  time? 
it  will  be  used  in  the  very  restricted  sense  indicated  above.  In 
still  other  connections  it  will  have  some  meaning  lying  between 
these  extremes.* 

The  foregoing  discussion  of  economic  phenomena  has 
brought  out  the  point  that  things  are  economic  only  when  looked 
at  in  one  special  way.  To  emphasize  this  phase  of  the  matter 


*It  is  important  for  the  student  to  learn  early  in  his  career  that  there 
is  no  possibility  of  defining  the  limits  of  economics  or  any  other  science 
vith  absolute  precision.  There  are  no  precise  limits  to  the  field  of  any 
Science ;  and  the  effort  to  set  up  such  limits  is  likely  to  result  in  a  pedantic 
narrowness  quite  inconsistent  with  the  truly  scientific  spirit.  It  is  stil'i 
true,  however,  that  the  general  character  of  the  phenomena  dealt  with  in 
any  particular  science  can  be,  and  ought  to  be,  fairly  well  comprehended  at 
the  outset. 


INTRODUCTION 

still  further,  it  should  be  added  that  there  is  an  economic  aspect 
of  many  matters  which  the  public  generally  and  even  many 
economists  are  wont  to  look  on  as  quite  remote  from  the 
economic  world.  Thus,  the  ministrations  of  religion  seem 
very  far  removed  from  those  things  which  are  commonly 
thought  of  as  wealth,  such  as  bread,  meat,  houses,  and 
so  on.  But,  in  truth,  these  strongly  contrasted  things  are 
really  in  the  same  class.  Bread,  meat,  houses,  and  so  on  have 
an  economic  character,  not  because  they  satisfy  very  material, 
everyday  wants,  but  because  in  view  of  all  the  conditions  of  the 
case  they  have  value — have  to  be  paid  for.  And  just  so  the 
ministrations  of  the  clergy  have  an  economic  character  because 
they  have  to  be  paid  for.  Our  science,  .therefore,  has  to  do 
with  almost  everything  high  or  low,  great  or  little,  but  only  on 
one  side  of  that  thing,  viz.,  the  one  which  we  call  its  economic 
side. 

In  the  second  paragraph  back,  we  spoke  of  economic 
phenomena  as  forming  the  subject  matter  of  Political  Economy 
just  as  certain  other  phenomena  form  the  subject  matter  of 
Chemistry,  still  others  that  of  Physics,  and  so  on.  We  perhaps 
ought  to  note  one  point  of  difference  between  economic 
phenomena  and  the  others  alluded  to.  The  latter  belong  to  a 
general  group  which  is  in  the  strictest  sense  natural,  i.e.,  not 
modified  through  conditions  fixed  by  men.  Economic  phenomena, 
in  contrast,  belong  to  a  group  which  are  in  no  small  degree 
artificial,  i.e.,  influenced  by  conditions  of  human  origin.  Of 
course  all  phenomena  are  natural  in  the  broadest  sense  of  the 
term.  Thus,  it  is  natural  for  men  to  play,  hence  natural  for 
them  to  invent  apparatus  and  arrange  conditions  for  play,  hence 
natural  to  invent  games  of  cards,  form  card  clubs  and  so  on. 
But,  obviously,  some  things  are  natural  in  a  fuller  and  deeper 
sense  than  are  others.  Thus  a  state  is  more  truly  a  natural 
organization  than  is  a  card  club.  So  the  family  is  even  more 
truly  natural  than  is  the  state.  Now,  many  economic  relations 
are  among  the  most  truly  natural  and  inevitable  which  can  be 
formed;  many  economic  phenomena  would  be  just  like  those 
we  are  familiar  with  in  the  same  connections,  even  if  we  lived 
like  Crusoes  or,  at  the  opposite  extreme,  like  a  communistic 
society.  But,  in  contrast  with  these,  not  a  few  economic 
phenomena  would  be  very  different  from  what  they  are  now, 
provided  certain  legal  changes  were  introduced.  Thus,  the 


PRINCIPLES  OF  ECONOMICS 

amount  of  wealth  enjoyed  by  many  persons  would  be  quite 
different  if  the  state  owned  all  the  land.  So,  it  is  probable  that 
not  a  few  more  or  less  considerable  changes  in  prices  would 
take  place,  if  all  undertaking  of  production  were  left  to  the 
state.  Again,  to  permit  laborers  to  be  owned  like  beasts  of 
burden  would  surely  modify  many  important  economic  phenomena. 
The  preceding  illustrations  of  artificial  economic  conditions  were 
cases  of  formal  legislation.  But  it  is  plain  that  such  conditions 
can  be  brought  about  by  custom,  convention,  formal  agreements, 
and  so  on.  Thus,  a  really  general  boycott  of  manufacturers 
who  employed  non-union  laborers  would  be  an  artificial  condi- 
tion of  sufficient  significance  to  influence  wages  and  employment 
quite  seriously. 

This  discussion  of  artificial  conditions  quite  naturally  sug- 
gests a  conception  which  will  be  of  much  importance  in  our 
future  study;  I  mean  the  conception  of  an  economic  order,  i.e., 
a  system  or  totality  of  conditions  natural,  legal,  customary,  etc., 
under  which  economic  goods — wealth — are  brought  into  exist- 
ence, distributed,  and  consumed.  Many  such  economic  orders 
might  be  conceived,  though  there  are  only  a  few  principal  types. 
But  our  chief  business  is  with  the  existing  economic  order,  the 
one  at  present  dominant.  Our  special  task  as  students  of  eco- 
nomics is  to  ascertain  the  leading  facts  of  this '  order  and  the 
principles  or  natural  laws  governing  economic  phenomena  under 
this  order. 

The  preceding  will  suffice  to  give  the  student  fairly  adequate 
ideas  as  to  the  nature  of  economic  phenomena.  It  surely  is 
hardly  necessary  to  remark  that  these  phenomena  present  prob- 
lems of  great  interest  and  importance.  For  some  of  these 
problems  we  shall  have  to  admit  that  there  is  not  now,  and 
perhaps  never  will  be,  any  complete  solution.  In  not  a  few 
other  cases,  the  matter  requires  only  careful  and  patient  study. 
At  the  very  worst,  we  shall  get  a  considerable  amount  of  knowl- 
edge which  is  quite  certain  and  more  or  less  useful.  This  per- 
haps sounds  too  optimistic,  in  view  of  the  fact  that  we  often 
hear  people  who  are  seemingly  quite  intelligent  declare  that  there 
are  no  economic  principles,  that  there  is  no  economic  science, 
that  in  economic  matters  we  could  not  make  the  smallest  pre- 
diction with  any  hope  of  its  being  fulfilled.  Now,  this  is  very 
silly  if  intended  to  be  taken  seriously.  Any  fairly  intelligent 
person  can  work  out  on  the  spur  of  the  moment  many  examples 


INTRODUCTION 

of  possible  predictions  in  economic  matters  which  would  cer- 
tainly be  fulfilled.  For  example,  if  there  should  be  a  great 
falling  off  in  wheat  production  next  year,  the  price  would  cer- 
tainly rise.  If,  by  the  introduction  of  new  methods,  the  cost  of 
producing  almost  any  manufactured  article  were  to  fall,  say, 
fifty  per  cent. — monopoly  being  shut  out — the  price  of  such  article 
would  also  fall.  If  the  price  of  aluminum  should  decline,  say, 
fifty  per  cent.,  there  would  doubtless  take  place  a  great  extension 
of  its  use  in  the  arts.  If  the  government  should  begin  to  coin 
freely  both  gold  and  silver,  putting  only  sixteen  times  as  much 
silver  into  that  kind  of  coin  as  it  does  of  gold  into  that  kind 
when  on  the  open  market  an  ounce  of  gold  is  worth,  say,  forty 
ounces  of  silver,  the  silver  would  surely  get  the  place  of  standard 
money  while  gold  would  go  to  a  premium  and  rapidly  disappear 
from  circulation.  And  so  one  might  go  on.  In  short,  economic 
phenomena,  like  any  other  phenomena,  are  governed  by  natural 
laws.  If  the  particular  group  of  phenomena  in  question  are  of 
such  a  nature  that  several  almost  equal  forces  are  interacting, 
it  may  be  impossible  to  anticipate  the  resultant  effect,  just  as 
in  complicated  natural  or  physical  sciences  like  physiology  or 
meteorology.  But,  in  other  cases  when  only  one  or  two  of  the 
forces  in  operation  are  of  any  considerable  significance,  it  will 
be  comparatively  easy  to  ascertain  the  probable  outcome  of  the 
totality  of  conditions. 

On  account  of  the  very  great  practical  significance  of  eco- 
nomic matters  to  every  person,  the  student  is  generally  tempted 
to  make  immediate  and  confident  application  of  every  bit  of 
economic  knowledge  which  he -may  acquire.  Such  procedure  is 
not  justified  in  any  science;  since,  whatever  the  science  one  is 
studying,  some  time  must  be  spent  acquiring  those  most  general 
principles  the  actual  working  of  which,  though  very  fundamental, 
is,  after  all,  much  obscured  by  the  operation  of  more  superficial 
forces.  In  the  case  of  economic  phenenoma,  this  too  hasty 
application  of  fundamental  principles  to  specific  cases  is  even 
less  justified  than  elsewhere,  because  of  the  great  number 
of  economic  and  non-economic  forces,  which  are  simultaneously 
acting  at  any  given  moment  and  which  make  the  accurate  disen- 
tangling of  causes  almost  impossible.  It  is,  therefore,  quite 
important  that  the  student  should  exercise  much  self-control  at 
this  point.  In  particular,  he  is  urged  to  suspend  final  judgment 
on  almost  all  great  practical  problems,  such  as  free  trade, 


PRINCIPLES  OF  ECONOMICS 

socialism,  trades  unionism,  etc.,  till  he  takes  courses  subsequent 
to  Course  ?.,  of  anyhow  till  late  in  that  course.  This  exhortation 
is  the  more  needed  because,  in  the  process  of  trying  to  secure 
a  thorough  comprehension  of  principles,  it  seems  necessary  to 
make  many  applications  of  those  principles  to  actual  problem?. 
If,  however,  the  student  will  remember  that  in  these  applications 
we  are  concerned  only  with  the  economic  phase  of  the  matter 
while  the  practical  problem  has  many  other  phases,  he  will  real- 
ize that  in  this  connection  he  should  attempt  to  reach  a  final 
opinion,  not  on  the  whole  matter,  but  only  on  the  economic 
phase  involved. 

As  already  implied  in  the  above  discussion,  the  course  upon 
which  we  are  just  now  entering  is  primarily  intended  as  a  founda- 
tion for  later  study.  It  is,  therefore,  devoted  to  a  severe  disci- 
pline upon  fundamental  principles  and  their  applications.  In. 
general,  our  method  of  procedure  is  to  introduce  in  a  concrete 
way  the  phenomena  needing  explanation ;  then  to  set  forth  in 
,  \  quite  formal  fashion  the  princip!e  which  embodies  the  explanation; 
to  follow  this  with  adequate  illustration  and  argument;  then  to 
finish  with  illustrative  problems  the  solving  of  which  will  ensure 
that  the  student  really  masters  the  principle  involved.  In  order 
to  get  the  best  results,  we  would  advise  that,  in  preparing  the 
lesson,  the  student  should  begin  by  reading  the  text  carefully, 
though  not  attempting  to  master  it;  that  he  should  then  under- 
take to  solve  the  illustrative  problems,  recurring  to  the  statement 
and  discussion  of  principles  as  he  feels  the  need  therefor;  and 
that,  finally,  he  should  go  over  the  entire  discussion  once  more 
in  order  to  get  a  better  comprehension  of  the  matter  as  a  whole. 
The  best  results  can  be  obtained  from  the  problems  by  writing 
out  the  solution.  In  doing  this,  do  not  rest  satisfied  with 
categorical  answers  even  when  these  would  seem  sufficient; 
rather  take  pains  to  explain — give  reasons  for — the  conclusion 
reached.  Where  argument  is  needed,  be  careful  to  put  in  every 
link  in  the  chain  and  to  put  each  in  its  proper  place.  Cultivate 
clearness  and  precision  of  statement. 

ILLUSTRATIVE  PROBLEMS. 

1.  "In  order  to  be  an  economic  good — wealth — a  thing  must 
have  utility, — must  be  capable  of  satisfying  some  want."  Argue 
for  the  truth  of  this  statement. 

Answer:     The  distinguishing  mark  of  an  economic  good  if 

6 


INTRODUCTION 

the  fact  that  it  has  value.  But  no  one  will  set  value  on  a  thing 
unless  it  is  capable  of  satisfying  some  want  of  his; — i.e.,  unless 
it  has  utility.  Hence  to  be. an  economic  good,  it  must  have  utility. 

2.  Is  air  under  ordinary  conditions  wealth? 

3.  Show  that  in  order  to  be  wealth  a  thing  must  be  appro- 
priable and  transferable. 

4.  Is  the  water  flowing  from  a  spring  by  the  roadside  wealth? 

5.  Is    an    amiable   disposition   wealth?     A   hundred   tons   of 
gold  known  to  be  lying  on  the  surface  of  the  moon?     A  vein 
of  coal  existing,  but  not  known  to  be  existing,  under  a  Michi- 
gan farm? 

6.  "If  all  the  whisky,  brandy,  gin,  and  other  alcoholic  drinks 
in  existence  were  taken  out  and  poured  on  the  ground,  there 
would  not  be  one  whit  less  wealth  or  value  in  the  world  than 
before  the  operation."    Is  that  sound? 

7.  It  would  cost  a  good  deal  of  labor  to  cover  the  walls  of 
the  houses  on  Washtenaw  avenue  with  posters  of  a  circus  given 
two  weeks  ago.    Would  the  result  be  wealth?    What  is  the  point 
to  be  made? 

8.  "A  thing  may  have  value  and  not  be  useful:  e.g.,  an  old 
stone  prized  by  a  collector."     Point  out  the  error. 

9.  When  we  call  a  man  wealthy  we  mean  that  he  possesses 
a    relatively   large   amount   of    this    world's    goods.      Should   we 
understand  this  to  mean  that  the  possessions  of  the  poor  man 
are  not  wealth? 


CHAPTER  I. 

PRELIMINARY    ACCOUNT    OF    THE    EXISTING 
ECONOMIC  ORDER. 

In  the  introduction  we  developed,  among  other  things,  the 
motion  of  an  economic  order — a  totality  of  conditions  under 
which  economic  phenomena  take  place;  and  we  explained  that 
our  study  is  mainly  concerned  with  the  particular  economic 
order  now  existing, — the  phenomena  displayed  under  it  and 
the  natural  laws  governing  those  phenomena.  Our  first  task 
is  to  get  a  genera!  view  of  this  economic  order,  to  familiarize 
ourselves  with  its  most  conspicuous  features,  before  undertaking 
its  more  detailed  study. 

Section  A.    The  Dominant  Features  of  the  Present 
Economic  Order. 

1.  It   is   easy  to   imagine   an   economic   order   wherein   each 
person  produces  the  very  things  which  he  consumes, — bakes  the 
bread   he   eats   from   flour  he  has   ground   from  wheat  he  has 
raised.    Such  an  order  might  be  called  an  Autonomous  economic 
order.    But  the  actual  system,  as  we  all  know,  is  far  different. 
Most  of  the  goods  which  each   of   us  consumes   are,   speaking 
literally,   produced  by   others,   while   most   of   those   which   each 
produces  are  consumed  by  others.     In  short  the  present  order 
is   not  autonomous   but   cooperative.    Herein   is  the   most   im- 
portant single  characteristic  of  that  order. 

2.  The  second  important  fact  about  our  present  system   is 
to  be   found  in   the  peculiar  way  in  which   our  cooperation   is 
effected,  brought  about.     When  the  word  cooperation   is  used, 
the    first  thought   suggested   is  that  of   a   system   in   which   we 
act  together  as  the  result  of  an  agreement  entered  into,  or  of 
authority  exercised  over  us  by  some  outside  power.     Thus,  peo- 
ple cooperate,  in  getting  up  a  church  supper  or  a  picnic,  through 
agreement.      On    the    other    hand,    in    the    family    we    have    a 
cooperation  which  is  brought  about  by  the  authority  of  one  or 


PRINCIPLES  OF  ECONOMICS 

both  of  the  parents.  Such  cooperation  is  conscious,  organized. 
This  type  is  present  in  communistic  societies  many  of  which 
have  existed  in  the  United  States,  e.g.,  the  Shakers,  Oneida, 
Amana,  etc.  In  contrast,  with  such  conscious,  organized,  co- 
operation, that  of  the  present  order  is  largely  spontaneous, 
unconscious,  organic.  Each  man  produces  some  commodity  or 
service  and  exchanges  it  for  the  commodities  or  services  of  his 
neighbors.  In  doing  this,  he  and  they  really  cooperate,  but  they 
are  scarcely  conscious  that  this  is  true.  In  fact,  when  they  are 
first  told  that  this  is  the  case,  the  statement  almost  always  has 
to  be  emphasized  very  roundly  to  gain  their  assent;  though 
when  once  apprehended  it  seems  very  obvious.  Now  the  fact 
just  brought  out  is  expressed  by  saying  that  our  cooperation 
in  the  present  order  is  effected,  brought  about,  through  exchange. 
And  accordingly  we  denominate  that  order  as  one  of  Exchange 
Cooperation. 

3.  But  there  is  another  reason  for  calling  this  order  one 
of  exchange-cooperation.  It  is  pretty  clear  that,  if  we  have 
any  cooperation  at  all,  there  must  be -some  way  of  regulating 
that  cooperation.  We  need  more  of  some  things  than  of 
others.  We  need  certain  things  so  much  that  it  will  pay  us  to 
have  them  even  at  the  cost  of  going  without  some  other  things 
altogether.  Unless  there  is  some  guiding,  directing,  machinery, 
we  shall  be  wasting  our  resources  producing  the  wrong  things 
or  the  right  things  in  the  wrong  proportion.  Now,  in  some 
kinds  of  cooperation  this  regulating  is  done,  or  would  be  done, 
by  authority.  This  is  the  case  within  the  family.  How  much 
time  the  farmer's  boy  shall  put  in  weeding  the  garden,  how 
much  splitting  wood,  how  much  picking  up  stones,  and  so  on, 
the  farmer  determines  by  authority;  and  such  a  system  prevails 
in  the  main  in  the  communistic  societies  to  which  reference  has 
already  been  made.  But,  throughout  most  of  the  present  order, 
our  cooperation  is  regulated  by  the  same  machinery  of  exchange 
which  effects  that  co-operation,  and  in  the  same  spontaneous 
way.  If  too  little  of  anything  is  produced,  prices  rise  or  the 
market  expands,  profits  increase,  and  so  producers  of  their  own 
motion  increase  output;  if,  on  the  other  hand,  too  much  of 
anything  is  produced,  prices  fall  or  the  market  contracts,  profits 
diminish,  and  so  producers  of  their  own  motion  diminish  output. 
Again,  if  the  output  of  some  commodity  during  a  particular  year 
is  exceptionally  small,  so  that  consumption  all  along  the  line 

10 


CHAPTER  I.  GENERAL  SURVEY. 

needs  to  be  curtailed,  this  is  usually  accomplished,  not  by  the 
interposition  of  the  public  authorities,  but  by  an  automatic 
rising  of  price  which  induces  almost  every  one  to  cut  down  con- 
sumption of  his  own  motion.  So,  in  various  other  ways,  ex- 
change regulates  our  cooperation. 

Note:  The  preceding  paragraph  has  brought  out  the  point 
that  regulation,  in  the  existing  economic  order,  is  through  ex- 
change. This  obviously  takes  for  granted  the  proposition  that 
there  is  regulation  of  some  sort.  This  assumption,  however,-- 
needs  emphasis;  for  there  is  nothing  more  common,  even  among 
educated  people,  than  the  notion  that,  save  in  so  far  as  there 
is  conscious  interference  with  the  working  of  things,  the  present 
order  is  without  regulation,  is  chaos,  anarchy, — chance  alone 
reigns.  Now,  this  is  surely  quite  contrary  to  the  facts.  Eco- 
nomic actions,  viewed  from  either  the  individual,  or  the  general, 
standpoint,  are  regulated  actions.  They  are  spontaneously  or- 
ganized, correlated,  so  as  to  accomplish  uniform  and  regular 
results.  There  is  an  ideal,  a  standard,  as  to  how  economic  mat- 
ters ought  to  be  managed,  ordered,  which-  is  probably  realized 
as  fully  as  any  ideal  which  society  sets  for  itself.  Said  ideal  of 
economic  ordering  may  not  be  the  best,  may  even  be  the  worst, 
conceivable;  but  it  is  in  a  high  degree  realized;  and,  so,  eco- 
nomic action  is  not  unregulated,  chaotic,  the  prey  of  chance. 
As  to  the  general  soundness  of  this  statement,  the  student  can 
easily  convince  himself  from  his  everyday  experience.  The 
more  specific  and  complete  argument  for  it  will  be  supplied  as 
our  knowledge  of  the  economic  order  expands  in  the  progress  of 
this  course. 

We  have  emphasized  the  thesis  that  there  is  regulation  in  th 
present  order, — that  it  is  not  given  over  to  chaos ;  we  must  not 
neglect  to  disclaim  any  intention  of  characterizing  the  regula- 
tion actually  effected  as  altogether  just  and  expedient.  The 
time  has  not  come  to  go  into  this  matter  at  all  fully;  but  even 
at  this  stage  so  much  should  be  made  clear.  No  one  claims 
that  the  present  system  works  perfectly,  that  there  are  no  evils 
which  society  ought  to  try  to  eliminate  by  authoritative  regula- 
tion. That  a  system  wherein  regulation  was  effected  automatic- 
ally, spontaneously,  would  work  well,  without  any  tincture  of 
authoritative  regulation,  no  one  would  affirm.  The  most  enthu- 
siastic advocates  of  a  let-alone  policy  have  demanded  that  degree 
of  governmental  interference  which  is  necessary  to  exclude  force, 
fraud,  and  violations  of  contract.  Further,  as  was  shown  by 
Mill  more  than  sixty  years  ago,  in  the  actual  world  authorita- 
tive regulation  goes  much  beyond  this,  and  does  so  with  almost 
universal  approval.  Now,  it  surely  would  be  very  silly  to  claim 
that  this  policy  has  been  carried  just  as  far  as  it  ever  ought  to 
be.  There  surely  are  left  not  a  few  places  where  spontaneous 
regulation  fails  to  attain  good  results ;  and  it  surely  is  possible 
that  at  some  of  these  points  authoritative  regulation  would  do 

11 


PRINCIPLES  OF  ECONOMICS 

better.  Finally,  it  is  entirely  possible  that  in  the  end  organized 
society  will  come  to  look  on  the  present  system  of  regulation 
as  so  greatly  inadequate  that  it  will  be  constrained  to  adopt  a 
system  of  complete  authoritative  regulation  like  communism,  or 
one  in  which  such  regulation  is  only  a  little  less  complete,  i.e., 
socialism.  But  even  so,  even  admitting  the  final  unbearableness 
of  the  present  order,  we  should  still  have  to  insist  that  this 
order  is  not  chaotic,  anarchic, — that  it  is  a  regulated  and  a 
rationally  regulated,  order,  though  one  in  which  the  process  of 
regulation  is  automatic. 

4.  We   have   seen  that  the  present  economic  order   is   one 
wherein  men  cooperate  and  wherein  their  cooperation  is  effected 
and    regulated   through    exchange.      The    next    most    important 
characteristic  of  the  present  order  is  individual  initiative.     It  is 
quite  possible  to  conceive   a  system   of  cooperation   which,   in- 
part  at  least,  is  effected  and  regulated  through   exchange,  but 
in  which  initiative  is  left  to  society  as  a  whole,  government. 
This  would  be  the  case  under  socialism  as  it  is  commonly  ad- 
vocated.    In  such  a  system  the  state  would  be  the  sole  farmer, 
miner,  manufacturer,  merchant,  et  al.,  i.e.,  the  state  alone  would 
undertake   to    produce   things,    putting   all    individuals    into   the 
position  of  employees.     But  it  would  enter  into  relations   with 
these  individuals  under  the  conditions  of  free  contract,  buying 
their  services  in  the  open  market.     Further,   it  might,  probably 
would,  pay  for  these  services  prices  determined  under  the  free 
working  of  the  laws  of  value.    So,  in  determining  what,  and  how 
much,  should  be  produced,  it  would  probably  be  guided  by  the 
fluctuations  of  freely  determined  prices.     (For   example,  if  the 
price  of  some  particular  thing  went  down,  the  government  would 
take  this  as  a  warning  to  diminish  the  production  of  that  thing.) 
But,  while  such  a  system  would,  like  the  present,  be  a  system 
of   exchange   cooperation,    it   would    differ   radically   in    leaving 
all  initiative  to  the  state;  whereas,  in  the  present  order,  initia- 
tive is  mostly,  though  not  entirely,  the  business  of  the  individual, 
— persons  who  have  the  means  and  think  they  see  a  chance  to 
obtain  profits  set  about  producing  wheat  or   iron  or  chairs   or 
dishes,    etc.      Accordingly,    to    give    something    like    a    complete 
characterization   of  the  present  order   in   its   most   general   fea- 
tures we  have  to  say  that  it  is  a  system  of  Individual  Exchange 
Cooperation. 

5.  The  preceding  discussion  has  laid  much  stress  on  the  fact 
that  the   existing  order  is  cooperative.     In   thus  characterizing 

12 


CHAPTER  I.  GENERAL  SURVEY. 

that  order  we  almost  necessarily  say  that  it  is  one  wherein 
specialization  prevails,  i.e.,  one  in  which)  different  persons 
devote  themselves  to  doing  different  things, — one  man  makes 
shoes,  another  clothes,  another  bread,  and  so  on.  Doubtless 
there  are  occasions  when  homogeneous  cooperation,  i.e.,  co- 
operation of  persons  doing  the  same  sort  of  things,  is  of  decided 
advantage,  e.g.,  a  barn  raising;  but  cooperation  would  have 
very  slight  significance  compared  with  what  it  now  has  did  it 
not  also  prevail  in  the  form  of  heterogeneous  cooperation,  i.e., 
a  cooperation  in  which  the  different  participants  do  different 
things.  Further,  the  successful  working  of  heterogeneous  co- 
operation would  require  that  the  differentiation  of  tasks  should 
be  more  or  less  permanent, — each  'one  should  make  a  practice 
of  doing  one  sort  of  thing  only.  That  is,  we  should  have  to 
have  thorough-going  specialization.  And  of  course  this  is  what 
we  do  have  in  the  present  order.  Each  devotes  himself  to  doing 
one  sort  of  things,  acquiring  in  this  way  extraordinary  skill 
and  efficiency.  Further,  the  same  rule  of  specialization  is  ap- 
plied to  the  instruments  used  in  production,  the  tools  and 
machines, — till  more  and  more  each  is  fitted  for  one  very  small 
job.  Finally,  the  same  idea  is  carried  out  with  respect  to  land, — 
one  district  being  devoted  to  celery,  another  to  onions,  another 
to  citrous  fruits,  and  so  on. 

ILLUSTRATIVE  PROBLEMS. 

1.  Give  some  examples  of  autonomous  production  from  every- 
day experience. 

2.  "Robinson   Crusoe,    on   his   far-away   island,   had  neither 
trade  nor  commerce.     Except  for  the  supplies  that  he  recovered 
from  the  wreck  of  the  ship,  he  obtained  his  food  from  the  plants 
that   he   cultivated    and   from   the    wild   animals   that    he   killed. 
His  clothing  was  made  from  the  skins  of  goats;  his  table  and 
his  chairs  were  the  work  of  his  own  hands.     Even  his  shelter 
was  constructed  of  the  stone  and  wood  that  he  found  on  the 
island.     If  he  had  more  of  one  product  than  he  needed  he  could 
not    exchange    it    for    other    necessary    articles.      If    provisions, 
utensils,   clothing,   tools,   or  metals   were  lacking,  he  could  not 
buy   them.     He   was    by  turns   hunter,    fisher,    tanner,    farmer, 
miller,  baker,  blacksmith,  and  carpenter." 

The  above  is  the  opening  paragraph  of  a  book  on  Commercial 
Geography.  It  seems  intended  to  suggest  the  significance  and 
importance  of  commerce  by  setting  forth  the  disadvantages  of 
isolation  such  as  Crusoe's.  Put  the  gist  of  the  matter  in  a 
single  sentence. 

13 


PRINCIPLES  OF  ECONOMICS 

3.  "In    the    main,    industry    is    organized    in    a    spontaneous 
way.     Men  choose  such  occupations  as  they  like,  and  when  there 
are  too  many  of  them  in  one  group  and  too  few  in  another,  the 
automatic   working   of    economic   forces    moves    them    from   the 
former  into  the  latter."     Explain  and  illustrate  the  last  clause  of 
that  sentence. 

4.  "The  great  advantage  of  foreign  trade  is  in  furnishing  a 
market  for  our  surplus  products  which  would  otherwise  go  to 
waste."    This  surely  is  only  a  minor  advantage  of  foreign  trade. 
Why?     Give  something  better. 

5.  If  the  potato  crop  of  a  communistic  society  which  had  no 
commerce  with  other  communities  were  to  fall  off  one-half,  how 
would  they  regulate  the  consumption  of  potatoes  for  the  follow- 
ing year?    How  is  it  done  under  the  present  order? 

6.  "It  will  never  pay  us  to  import  anything  which  we  our- 
selves can  produce."     Show  that  this  proposition  is  erroneous. 

Section  B.     Principal  Advantages  of  Cooperation,  Looked  at 
from  the  Standpoint  of  Individuals. 

It  is  probably  unnecessary  to  spend  much  time  arguing  that 
cooperation  in  economic  matters  will  surely  prove  far  more 
efficient  than  independent  action.  But  we  can  hardly  pass  the 
matter  without  pointing  out  two  or  three  of  the  most  con- 
spicuous advantage  of  such  cooperation. 

1.  Cooperation  enables  the  individual  to  enjoy  not  a  few 
goods  which  otherwise  he  could  not  enjoy  at  all  because  he 
could  not  produce  them.  Thus,  (a)  Homogeneous  cooperation 
makes  possible  results  which  no  person  acting  alone  can  bring 
about,  and  which,  therefore,  the  individual  could  not  enjoy  were 
it  not  for  cooperation,  (b)  Heterogeneous  cooperation — doing 
different  things  and  exchanging  the  products — often  enables  the 
individual  to  get  and  enjoy  goods  which  he,  anyhow,  can  not 
produce,  whether  acting  alone  or  with  others,  and  which,  there- 
fore, he  could  not  have  at  all  were  he  dependent  on  himself 
entirely.  Thus  some  articles  can  be  produced  in  only  a  few 
places.  Some  services  can  be  performed  by  only  a  few  persons. 
A  literally  complete  exclusion  of  cooperation  would  mean  death 
to  not  a  few  persons. 

Note:  Put  in  a  slightly  different  way,  cooperation  enables 
every  one  who  has  any  capacity,  however  small,  for  doing  things 
which  people  want  done,  to  utilize  such  capacity  in  getting  the 
things  he  needs,  even  though  his  powers  are  inadequate  to  per- 
form a  hundredth  part  of  the  tasks  which  he  himself  needs  to 
have  performed  every  day. 

14 


CHAPTER  I.  GENERAL  SURVEY 

2.  Cooperation  enables  the  individual  to  enjoy  a  far  larger 
quantity  of  those  goods  which  he  himself  could  produce.    Special- 
ization  enables  both   the   farmer   and  the   carpenter  to   become 
more  productive  than   if  each   worked  at  both  trades.     Conse- 
quently, each,  in  cooperating  with  the  rest,  gives,  and  so  gets, 
more  goods  than  he  would  if  he  worked  by  himself. 

3.  Cooperation  enables  the   individual  to  enjoy  a   far  better 
quality  of  goods  than  otherwise.     Specialization  enables  each  to 
produce    better    goods    than    if    he    tried    to    produce    all    kinds. 
Through    exchange-cooperation    each    gets    the    benefit    of    this 
improvement. 

ILLUSTRATIVE  PROBLEMS. 

1.  Name    five    or    six    commodities    or    services    which    you 
could  not  have  at  all  if  you  did  not  cooperate  in  some  measure 
with  other  persons. 

2.  Name  three  or  four  economic  goods  which  you  could  not 
have  at  all  if  you  did  not  cooperate  with  persons  in  some  other 
part  of  the  world. 

3.  Name  two  or  three  kinds  of  goods  which  could  be  pro- 
duced in  your  neighborhood  but  which  you  obtain  more  cheaply 
through  cooperating  with  the  people  of  other  districts. 

4.  Might    it    pay    you    to    buy    from    other    districts    things 
which  you   could  produce  almost  as   well  as  the  things  you  do 
produce? 

5.  Give  two  or  three  illustrations  of  how  a  specialized  tool 
naturally   does   a   better   job   in   respect  to   quality   than   a   non- 
specialized  one. 

6.  "During  1904  more  ships  were  built  on  the  Clyde  than  in 
the  whole  of  the  United  States.     This  fact  is  creditable  to  Great 
Britain  but  not  to  us."     Show  that  the  fact  stated  is  probably 
not  discreditable  to  the  United   States. 

7.  The   people   of   the    Copper   Country    in   Upper   Michigan 
mostly  buy  their  furniture  and  dry  goods  from  olher  parts  of 
the  country.     Does  this  prove  that  they  could  not  produce  good 
furniture  and  dry  goods  at  home?     If  not,  what  does  it  prove? 

Section  C.     Some  Formal  Principles  Based  on  the  Above 
General  Account  of  the  Present  Economic  Order. 

A  rather  notable  fact  in  this  age  of  general  education  and 
enlightenment  is  the  continued  acceptance  by  a  great  majority 
of  persons,  not  professional  economists,  of  quite  erroneous  no- 
tions with  respect  to  several  familiar  and  not  very  difficult 
matters.  In  fact,  one  can  scarcely  run  through  a  current  news- 

J3 


PRINCIPLES  OF  ECONOMICS 

paper  or  popular  magazine  without  coming  upon  fallacies  which, 
as  the  economist  looks  at  it,  were  fully  disposed  of  by  Adam 
Smith  almost  a  century  and  a  half  ago.  This  prevalence  of 
unsound  doctrine  is  particularly  troublesome  and  dangerous  in 
the  United  States  because  of  the  fact  that  the  majority  of  the 
people  have  the  power  to  rule  and  commonly  assert  that  power 
when  economic  problems  are  up  for  consideration.  Accordingly, 
one  of  the  most  important  tasks  of  the  student  of  Economics 
is  to  train  himself  in  the  art  of  detecting  the  fallacies  which 
^liirk  in  popular  errors.  Further,  this  task  confronts  us  at  the 
''very  outset  of  our  course;  for  some  of  the  most  widespread 
of  popular  errors  with  respect  to  economic  questions  are  con- 
nected with  matters  already  brought  out  in  the  above  general 
account  of  the  present  economic  order.  We  will,  therefore, 
at  once  set  about  formulating  principles  and  applying  them  to 
popular  errors. 

Caution :  At  the  very  beginning  of  this  kind  of  work,  how- 
ever, it  is  important  to  warn  the  student  of  certain  dangers 
which  are  apt  to  beset  him  in  dealing  with  these  fallacies,  as 
well  as  in  making  any  other  application  of  economic  principles. 
The  special  task  of  an  elementary  course  like  this  is  to  insure 
the  clear  apprehension  and  firm  mastery  of  fundamental  prin- 
ciples. We  therefore  put  those  principles  in  very  definite  form 
and  illustrate  them  with  hypothetical  problems  of  so  simple  a 
character  that  their  rigid,  dogmatic,  application  is  entirely  justi- 
fied. It  should  be  remembered,  however,  that  almost  all  the 
problems  which  real  life  presents  are  characterized  by  numerous 
and  complex  conditions.  In  actual  life,  therefore,  the  immediate 
and  hasty  application  of  economic  principles  is  highly  dangerous. 
Everything  taken  into  account,  a  given  line  of  policy  may  be 
justified,  although  the  economic  argument  commonly  given  for 
it  is  quite  ridiculous.  The  student  must,  therefore,  be  very 
cautious  in  applying  principles  to  concrete  cases — holding  himself 
open  to  receive  light  from  all  sources  and  looking  carefully  for 
conditions  which  neutralize  those  that  would  influence  him  as  an 
economist  to  decide  for  or  against  a  given  measure.  In  short, 
he  must  be  careful  not  to  develop  into  a  doctrinaire,  one  who 
insists  on  applying  principles  which  abstractly  speaking  are 
sound,  without  regard  to  the  varying  conditions  of  real  life. 

One  of  the  first  generalizations  from  the  nature  of  the  pres- 
ent order  which  we  have  to  lay  down,  brings  out  the  fact  that, 
generally  speaking,  each  gains  from  the  increased  efficiency 
of  his  neighbors.  This  comes  pretty  close  to  being  an  evident 
corollary  from  the  proposition  that  we  do  cooperate  in  economic 
matters.  As  long  as  we  cooperate,  act  as  one,  in  producing 

36 


CHAPTER  I.  GENERAL  SURVEY. 

goods,  an  increase  in  the  efficiency  of  the  persons  producing 
one  commodity  would  surely  increase  the  total  product  of  the 
group  and,  so,  would  naturally  be  expected  to  bring  advantage 
to  the  other  members  of  the  group  as  well  as  to  those  whose 
efficiency  had  increased.  It  might,  however,  be  argued  that, 
while  the  aggregate  product  of  the  group  would  surely  be  in- 
creased, this  would  not  necessarily  be  of  any  advantage  to  the 
other  members  of  the  group,  in  that  the  increase  might  all 
go  to  the  persons  whose  efficiency  had  increased.  Now,  the 
full  answering  of  this  objection  depends  on  a  knowledge  of  the 
principles  of  price  or  value  which  we  do  not  take  up  till  quite  a 
little  later  in  our  study.  Still,  it  will  not  be  difficult  to  antici- 
pate that  discussion  sufficiently  to  satisfy  the  student's  mind  in 
regard  to  the  general  point.  (1)  If  under  free  competition 
we  have  increased  efficiency  among  the  producers  of  a  given 
commodity,  no  change  taking  place  among  other  commodities, 
then  the  exchanging  rate  between  the  first  commodity  and  all 
the  others  will  alter  in  favor  of  the  others,  i.e.,  each  unit  of 
any  of  the  others  will  buy  more  units  of  the  first  commodity. 
(2)  Since,  by  hypothesis,  no  change  has  taken  place  among 
producers  of  other  goods,  the  exchanging  ratio  among  these 
goods  will  not  have  altered,  i.e.,  each  unit  of  any  one  of  these 
other  goods  will  buy  as  many  units  of  any  other  of  them  as 
before.  (3)  Consequently,  any  producer  of  one  of  the  other 
commodities  will  find  himself  able  to  buy  with  his  own  product 
more  units  of  the  product  in  respect  to  which  efficiency  has 
increased  while  buying  no  less  of  other  products,  that  is, 
he  will  have  gained  from  the  increased  efficiency  of  another 
set  of  producers. 

Caution  :  It  must  not  be  imagined  that  the  producers  whose 
efficiency  has  increased  make  no  gain.  Each  unit  of  their 
commodity  buys  less ;  but  they  have  more  units  to  buy  with,  and 
usually  this  will  mean  an  increased  total  of  other  goods. 

Formulating  the  point  brought  out  in  the  foregoing  dis- 
cussion, we  have  the  following 

Principle.  The  present  order,  being  a  cooperative  one,  each 
person  or  community  tends  to  gain  from  any  increase  in  the 
economic  efficiency  of  other  persons  or  communities  with  whom 
or  with  which  said  person  or  community  maintains  economic 
relations. 

17 


PRINCIPLES  OF  ECONOMICS 

A  second  matter  on  which  we  need  thus  early  to  lay  down 
a  formal  principle  is  the  function  of  trade,  exchange.  There  is, 
indeed,  almost  no  other  phase  of  economic  matters  on  which 
popular  opinions  are  so  much  astray.  In  the  minds  of  a  few 
persons,  all  trade  whatever  is  illegitimate „  To  a  much  larger 
number,  this  is  anyhow  true  of  some  kinds  of  trade.  In  the 
view  of  a  majority  of  persons,  probably,  trade,  if  legitimate  at 
all,  is  surely  unproductive  in  any  proper  sense  of  words.  Many 
persons  who  do  not  go  quite  so  far  hold  this  opinion  with 
respect  to  some  forms  of  trade.  Now,  it  is  hardly  necessary  to 
say  that,  if  the  account  which  we  have  given  in  this  chapter 
of  the  general  features  of  the  present  economic  order  is  sub- 
stantially sound,  all  these  adverse  judgments  about  trade,  ex- 
change, are  quite  untenable.  Trade  in  general,  and  presumably 
all  kinds  of  trade,  are  legitimate, — play  a  vital  role  in  economic 
affairs.  If  we  understand  by  the  word  productive  that  the 
operation  so  characterized  fulfils  a  condition  essential  to  the 
satisfying  of  our  wants,  then  trade,  in  some  form  certainly,  is 
productive!  These  points  may  be  formulated  in  the  following 

Principle.  Under  the  existing  economic  system,  exchange 
(trade,  commerce)  plays  an  essential  part  in  that  it  makes  pos- 
sible economic  cooperation  and  specialisation — it  supplies  the 
process,  or  system  of  processes,  whereby  cooperation  is  effected 
and  regulated. 

Let  the  student  argue  for  the  two  points:*  (1)  Ex- 
change is  necessary  to  effect,  bring  about,  cooperation.  (2) 
Exchange  is  necessary  to  regulate  cooperation.  Reflect  on 
such  questions  as  these:  (a)  What  good  would  the  baker  get 
from  making  500  loaves  of  bread,  without  exchange?  (b)  Of 
what  use  to  farmers  or  ultimate  consumers  of  wool  is  the 
local  wool  buyer?  (c)  Is  there  any  need  for  the  larger  buyers 
in  central  points  like  Denver,  Chicago,  New  York,  Boston  ? 
(d)  Suppose  there  were  a  big  shortage  in  the  cotton  crop, 
say  40  per  cent,  and  no  rise  in  price  took  place,  what  harm 
would  probably  result? 

Corollary  1.  Exchange  operations,  viewed  as  processes  nec- 
essary 1o  consummating  our  economic  cooperation,  are  pro- 
ductive operations,  and  those  engaged  in  such  operations  are 

*In  economics,  as  in  mathematics,  it  is  very  important  that  the  student 
should  learn  to  think  for  himself.  Just  as  far  as  possible,  therefore,  I 
shall  leave  him  to  make  for  himself  the  argument  needed  under  each  prin- 
ciple. In  the  case  before  us  surely  this  plan  is  feasible. 

18 


CHAPTER  I.  GENERAL  SURVEY. 

producers — productive  and  producers  being  employed  to  indicate 
that  the  operations  and  persons  in  question  supply  conditions 
essential  to  the  satisfaction  of  our  wants. 

This  proposition  so  plainly  follows  from  the  principle  that 
no  argument  is  needed. 

Corollary  2.  Exchange  operations,  viewed  as  processes 
whereby  our  cooperation  is  regulated  through  price,  are  pro- 
ductive operations  and  persons  engaged  in  such  operations  are 
producers. 

This  proposition,  again,  follows  quite  directly  from  our  prin- 
ciple. However,  it  may  need  some  little  comment.  Some  persons 
are  prepared  to  admit  that  mercantile  operations  are  productive 
in  so  far  as  they  are  devoted  to  buying  from  producers  and 
selling  to  consumers,  though  the  same  persons  would  be  dis- 
posed to  deny  the  productivity  of  such  operations,  in  so  far  as 
they  involve  the  fixing  of  prices.  But  the  principle  tells  us  that 
exchange,  trade,  is  responsible  for  the  proper  regulating  of  our 
economic  activity  and  that  this  part  of  its  work  is  largely  done 
through  changes  in  prices.  It  follows,  then,  that  exchange 
operations,  viewed  as  price-fixing  operations,  are  essential  to 
our  economic  efficiency  and  so  are  productive  operations. 

ILLUSTRATIVE    PROBLEMS. 

1.  "Give  the  farmer  a  parcels  post  to  begin  with.  Let  him 
send  his  dozen  eggs  or  his  pair  of  chickens  direct  to  the  man 
who  wants  to  eat  them,  or  at  least  to  the  retail  merchant.  Cut 
out  the  commission  merchant,  the  wholesaler,  and  a  few  other 
of  the  city  parasites  that  live  on  the  farmer." — New  York  Even- 
ing Journal. 

(a)  Suppose  yourself  to  be  a  farmer  living  in  the  neighbor- 
hood of  Ann  Arbor,  and  point  out  some  advantages  you  would 
derive  from  selling  your  butter  to  the  grocers  and  your  chickens 
to  the  meat  men  rather  than  to  consumers. 

(b)  Suppose    yourself    to    be    a    fruit    grower    in    Western 
Michigan,   dependent  for  your  market  chiefly  on  Chicago,   and 
point   out  some   disadvantages  which   you  would  suffer   if  you 
tried  to  sell  your  grapes,  peaches,  etc.,  by  parcels  post  to  the 
ultimate  consumers  in  Chicago  and  its  vicinity,  rather  than  to 
commission  merchants. 

(c)  Show  that  these  facts  are  inconsistent  with  the  notion 
that   commission    merchants,   wholesalers,    et  al.,   are    "city   par- 
asites." 

Note:  There  is  of  course  much  to  be  said  in  favor  of  a 
parcels  post;  and  it  is  always  possible  that  the  number  of 

19 


PRINCIPLES  OF  ECONOMICS 

middlemen  should  become  needlessly  large  so  that  some  of  them 
may  fairly  be  viewed  as  parasites.  But  such  a  characterization 
of  the  class  as  a  whole  is  quite  illegitimate. 

2.  "Internal   commerce    does   not   increase    the   wealth    of   a 
nation   since   it   only   transfers    goods    from    one  person   to    an- 
other."   Criticise. 

3.  In  the  natural  course  of  events   it   often  happens  that   a 
country  loses  some  portion  or  the  whole  of  its  market  in  some 
particular  country.     When  this  happens  or  is  anticipated,  public 
men  are  apt  to  speak  as  if  such  a  result  involved  almost  irreme- 
diable disaster.     Doubtless  it  would  mean  some  loss,  but  by  no- 
means  the  amount  which  people  seem  to  imagine.     Explain  pre- 
cisely what  would  be  the  nature  of  the  injury  to  us,  if  our  for- 
eign trade   should   fall   off  by  a   considerable   amount.     Suppose 
our  foreign  market  showed  a  permanent  net  shrinkage  of   200 
millions  of  dollars  per  annum  would  this  mean  that  our  yearly 
income  would  be  200  millions  smaller?     If  not  just  what  would 
it  mean? 

4.  From  the  Congressional.  Record  for  May  17,   1909:   "Mr, 
Aldrich:   Assuming  that  the   price   fixed   by   the   reports   is   the 
correct  one,  if  it  costs  10  cents  to  produce  a  razor  in  Germany 
and  20  cents  in  the  United  States,  it  will  require  100  per  cent 
duty  to  equalize  the  conditions  in  the  two  countries  .    .    .  And, 
so  far  as  I  am  concerned,  I  shall  have  no  hesitancy  in  voting 

for  a  duty  which  will  equalize  the  conditions. 

*  *  *  #'*  *  *  *  * 

If  it  was  necessary  to  equalize  the  conditions,  ...  I  would 
vote  for  300  per  cent  as  cheerfully  as  I  would  for  50."* 

To  what  sort  of  an  economic  system  would  such  notions,  if 
logically  carried  out,  inevitably  lead? 

5.  "A  first-class  illustration  of  the  absurdity  and  wrong  of 
the  present  order  is  furnished  by  the  case  of  a  plumbing  firm. 
Such  a  firm  does  little,  if  anything,  more  than  act  as  a  middle- 
man  between    the    actual    plumbers    and   householders.      But    it 
pays  the  former  at  the  rate  of,  say,  30  cents  an  hour  for  their 
services,   while   it   charges   householders   60   cents   an   hour    for 
those  services.     Here  you  have  a  plain  case.     Either  the  firm 
underpays   the   laborers    or   overcharges   the    householders;    and 
in  either  case  it  gets  something  which  it  has  no  right  to.    There 
is  no  other  alternative."       Discuss  the  above. 

6.  In  connection  with  nearly  all  of  the  great  staple  products, 
such  as  wheat,  corn,  oats,  cotton,  wool,  etc.,  there  is  commonly 
maintained  a  peculiar  sort  of  central  market,  usually  known  as 
an  exchange  or,  on  the  continent  of  Europe,  as  a  bourse.     The 
most  distinctive  characteristic  of  such  markets  is  that  the  major 
part  of  the  trading  carried  on  in  them  does  not  seem  to  have 
any  part  in  passing  the   commodity  on  from  the  original  pro- 
ducer to  the  ultimate  consumer,  but  rather  is  a  trading  backwards 


•Quoted  from  the  Quarterly  Journal  of  Economics  for  November,  1909, 

20 


CHAPTER  I.  GENERAL  SURVEY 

and  forwards,  to  and  fro,  between  the  members  of  the  same 
market,  leaving  the  commodities  just  where  they  were,  and 
apparently  having  no  object  save  the  getting  of  a  profit  which 
is  often  compared  to  the  gains  of  the  gambler.  By  not  a  few 
intelligent  and  able  men,  such  trading  is  characterized  as  quite 
illegitimate.  The  economist,  however,  insists  that  it  performs 
two  or  three  quite  important  functions.  One  of  these  is  said 
to  be  insuring  that  the  commodities  in  question  shall  have  just 
the  right  prices.  Try  to  think  of  some  reasons  for  believing  that 
a  great  speculative  market  with  the  most  elaborate  machinery  for 
getting  the  very  latest  information  in  respect  to  the  state  of  the 
crops,  the  stock  on  hand,  the  changes  in  demand,  and  so  on, 
would  tend  to  insure  that  prices  should  be  what  the  needs  of 
the  case  callfor. 

7.  "If  the  wheat  crop  of  the  world  should  fall  off  one-half 
next  year,  a  rise  in  price  would  then  be  of  great  social  advantage, 
in  fact,  almost  indispensable."    Explain. 

8.  The    general    account    of    the    existing    economic    order 
which  has  been  given  in  the  present  chapter  furnishes  one  of  the 
most  fundamental  objections  to  the  maintenance  of  a  protective 
tariff,   i.e.,  a   tariff   intended   to  hinder   our   buying  goods    from 
other  countries.     Explain  that  objection. 

Section  D.     A  More  Specific  Account  of  the  Forms  Which 
Cooperation   and .  Specialization   Assume   under  the    Present 

Order. 

In  our  general  account  of  the  cooperation  prevailing  under 
the  present  order,  no  attempt  was  made  to  go  into  the  matter 
at  all  specifically.  In  fact  it  was  vaguely  assumed  that  all  co- 
operation takes  a  form  wherein  each  producer  makes  some  one 
thing  from  first  to  last, — starts  it  and  finishes  it  ready  for  the 
consumer,  e.g.,  the  farmer  supplying  potatoes.  This  sort  of  co- 
operation we  might  distinguish  as  primary  cooperation  or 
primary  division  of  occupation.  But  every  one  knows  that  co- 
operation commonly  goes  much  further  than  this.  Almost  no 
one  carries  from  the  beginning  to  the  end  the  processes  neces- 
sary to  the  production  of  a  particular  consumption  good.  The 
work  of  the  baker  must  be  preceded  by  that  of  the  miller  and 
the  farmer.  So,  the  work  of  the  shoemaker  must  be  preceded  by 
that  of  the  tanner  and  the  stock  farmer.  Further,  between  each 
producer  in  the  series  and  his  successor,  must  come  the  dealer, 
the  middleman,  to  effect  the  necessary  transfer  of  the  product  be- 
tween the  independent  producers.  In  addition,  the  various  mem- 
bers in  the  original  series  make  much  use  of  the  products  and 
services  of  producers  in  other  series.  Thus,  the  dealers  who 

21 


PRINCIPLES  OF  ECONOMICS 

transfer  the  hides  from  the  stock-farmer  to  the  tanner  make 
use  of  the  services  of  various  producers  outside  the  series, 
especially  those  engaged  in  the  transportation  business.  Tanners 
again  use  coal  produced  by  another  group,  also  bark,  and 
various  chemicals.  In  like  manner,  shoemakers  use  thread, 
bristles,  needles,  machinery,  cloth,  etc.,  etc.,  which  they  obtain 
from  other  classes  of  producers  quite  outside  our  original  series. 
Here  then  we  have  division  of  occupation  within  division  of 
occupation.  We  might  call  it  secondary  cooperation  or  second- 
ary division  of  occupation. 

But,  in  an  economic  society  having  any  considerable  degree 
of  development,  cooperation  and  specialization  go  still  further 
than  has  yet  been  brought  out.  Even  in  the  last  case  we  were 
thinking  of  undivided  industrial  units,  though  each  was  devoted 
to  providing  only  some  one  element  in  the  ultimate  product; 
e.g.,  a  stock  farm  devoted  to  raising  cattle,  a  tannery  occupied 
in  preparing  hides  for  kather,  and  so  on.  But  we  all  know  that 
there  is  specialization  within  each  industrial  unit.  The  tannery, 
which  as  a  whole  produces  leather,  has  some  men  scraping  hides, 
some  attending  to  the  curing  of  the  hides  in  the  various  baths, 
some  staining,  some  finishing,  some  keeping  books,  some  writ- 
ing letters,  etc.  Obviously  this  sort  of  specialization  is  also  of 
very  great  significance.  Writers  have  sometimes  distinguished  it 
from  the  kinds  already  considered  as  Division  of  Labor;  while 
those  are  called  Division  of  Occupation. 

But  we  have  not  yet  brought  out  the  full  extent  of  co- 
operation and  specialization  under  the  present  order.  The  spe- 
cialization thus  far  considered  more  especially  grows  out  of 
the  differences  in  the  physical  or  technical  operations  to  be  per- 
formed, as  just  seen  in  the  case  of  tanning.  But  there  are  deeper 
differences  among  the  functions,  processes,  factors,  involved  in 
production.  Production  requires  that  some  man  possessing  more 
or  less  wealth  should  assume  the  responsibility  of  production; 
it  requires  that  he  should  have  land  upon  which  to  work ; 
it  requires  that  he  should  have  laborers  to  perform  the  different 
tasks ;  it  requires  that  he  should  have  materials,  tools,  and  ma- 
chines to  assist  these  men.  In  short,  to  use  the  more  technical 
language  of  Economics,  there  must  be  at  least  three  factors  of 
production:  land,  labor,  and  capital.  As  the  last  of  these  comes 
to  the  work  in  two  different  relations,  controlled  by  two  dif- 
ferent sets  of  persons,  we  have  in  reality  something  like  four 

22 


CHAPTER  I.  GENERAL  SURVEY 

groups  of  productive  agents  engaged  in  every  industry,  namely: 
landlords,  laborers,  capitalists  proper,  those  who  supply  the  cap- 
ital needed  in  production,  and  entrepreneurs,  those  owners  of 
wealth  who  assume  the  responsibility  of  production.  Here,  man- 
ifestly, we  have  a  deeper  sort  of  cooperation  and  specialization 
than  anything  yet  considered.  This  particular  kind  of  coopera- 
tion and  specialization  now  under  consideration,  I  will  for  the 
lack  of  a  better  term  designate  as  functional  cooperation.  We 
at  least  ought  to  realize  the  existence  of  such  a  system,  even  if 
we  seldom  have  occasion  to  make  special  reference  to  it. 

The  student  should  further  note  that  the  development  of  this 
functional  specialization  and  cooperation  brings  in  its  train  new 
cases  of  specialization  analogous  to  the  simpler  forms  already 
considered.  Thus,  the  more  completely  the  furnishing  of  cap- 
ital has  become  isolated  from  taking  the  responsibility  of  pro- 
duction, the  more  there  have  developed  institutions  for  dealing 
in  this  capital.  Prominent  among  such  institutions  are  com- 
mercial banks,  savings  banks,  trust  companies,  and  so  on. 

Note :  At  this  point  it  seems  desirable  to  remark  on  one 
very  important  general  result  of  the  great  extremes  to  which 
specialization  is  carried  in  the  present  order,  viz.,  that  this  fact 
gives  to  the  existing  system  an  extraordinary  complexity  which 
is  very  confusing  to  the  general  public  and  not  a  little  so  to 
the  trained  thinker.  It  is  often  difficult  to  isolate  the  precise 
function  played  by  a  particular  business ;  and  people  who  form 
hasty  conclusions  are  very  apt  to  deny  the  existence  of  such  a 
function,  to  affirm  that  the  business  in  question  plays  no  legiti- 
mate part,  so  that  those  who  pursue  it  are  mere  parasites  upon 
society.  The  student  should  studiously  avoid  this  practice.  In 
fact,  lie  will  do  well  to  assume  at  the  outset  that  every  occupa- 
tion, not  catering  to  human  vice,  plays  a  real  and  legitimate 
role  in  the  total  conduct  of  economic  affairs, — is  doing  some 
one  of  the  numberless  things  necessary  to  be  done  if  we  are  to 
attain  the  highest  economic  efficiency. 

To  summarize  this  discussion :  The  present  economic  system 
presents  itself  to  us  as  one  wherein  we  have  a  vast  complex  of 
different  industries,  mining,  stock-raising,  farming,  manufactur- 
ing, transporting,  etc.,  each  concerned  in  the  production  of  some 
commodity  at  one  or  another  stage  of  completion,  while,  within 
each  of  these  industries,  different  functional  groups  of  pro- 
ductive agents,  entrepreneurs,  capitalists,  laborers,  and  land- 
lords, are  cooperating,  and  while,  finally,  this  vast  industrial 
complex  is  brought  together,  is  held  together,  and  is  regulated 
through  exchange, — buying  and  selling. 

23 


PRINCIPLES  OF  ECONOMICS 

ILLUSTRATIVE  PROBLEMS. 

1.  On  South  University  is  a  little  shop  which  does  more  or 
less  making  of  shoes  to  order;  the  uppers,  however,  are  bought 
ready-made    from   some   large   manufacturing   house.     This   last 
fact   illustrates   either   division   of   labor   or   division   of   occupa- 
tion.    Which  ? 

2.  It    is    not    uncommon    to    group    together    the    principal 
industries    from    which    are   derived   the   ultimate    materials    out 
of   which,    and   with   the   aid   of    which,   goods    are    made,    e.g., 
copper,  coal,  wheat,  under  the  designation  Extractive  Industries. 
Enumerate  the  chief  subdivisions  of  this  group. 

3.  How  would  you  describe  the  difference  between  the   ex- 
tractive  industries   and   the   manufacturing? 

4.  Suppose  that  in  a  certain  farm  family  the  father  manages 
the  outdoor  work,  doing  much  of  the  heaviest  of  it;   the   wife 
cooks    and    keeps    house ;    the    daughters    wash    dishes,    set    the 
table,  etc.;  and  the  boys  bring  in  wood,  feed  the  chickens,  hunt 
eggs,   pick   berries,    etc.      What    is    illustrated   here,    division    of 
occupation  or  division  of  labor?     Explain. 

5.  When  one   concern   makes   bicycle   frames,   another   rims, 
another  spokes,  another  tires,  etc.,  etc.,  while  a  bicycle   factory 
buys  the  different  parts  from  the  different   concerns  alluded  to 
and  make's  them  into  a  completed  bicycle,  it  is  plain  that  the  co- 
operation of  these  different  producers  is  brought  about  and  reg- 
ulated through  exchange.     If,  however,  all  these  concerns  were 
to  be  consolidated  into  one  which  made  bicycles  from  the  ground 
up,  cooperation  would  then  be  effected  and  regulated  by  author- 
ity.    Show  that  there  would  still  be  in  the  establishment  much 
functional  cooperation  effected  and  regulated  through  exchange, 

6.  "The  whole  machinery  of  buying  and  selling  is  simply  a 
convenient  means  of  combining  effectively  the  various  factors  in 
production,    and    of    assigning    the    appropriate    shares    of    the 
product  to  those  who  have  claims  upon  it/' 

That  sentence  was  written  for  advanced  students  of  eco- 
nomic theory;  still  we  are  probably  prepared  to  get  the  main 
points  of  it.  Explain  what  you  understand  it  to  mean. 

7.  There  is  some  propriety  in  speaking  of  commerce,  trade, 
as  an  all-pervasive  kind  of  economic  activity,  entering  into  pro- 
ductive  processes    at   innumerable   points. 

Explain  and  illustrate. 

Section  E.     Some  Necessary  Legal  Conditions  of  the  Present 
Economic  Order. 

A  very  little  reflection  will  show  that  the  working  out  of  an 
economic  order  such  as  has  been  described  above  and  is  now 
existing  necessarily  involves  the  maintenance  of  various  legal 

24 


CHAPTER  I.  GENERAL  SURVEY 

conditions,  particularly  various  rights.    Here  follow  some  of  the 
most  important  of  these  rights. 

1.  Individual  Property,  not  only  in   final  products,  but  also 
in  factors  of  production,  land,  ultimate  raw  materials,  tools,  ma- 
chines,   etc.      By   the    right    to   property   is    meant   the    right    to 
exercise  substantially  exclusive  control  over  the  disposal  of  any 
thing — the  right  to  use  that  thing  oneself  and  to  hinder  others 
from  using  it.    To  some  degree  the  right  of  individual  (private) 
property  would  be  necessary  even  under  ^communism — e.g.,  each 
would  certainly  have  to  have  exclusive  disposal  over  articles  of 
food.     But,  under  our  present  system,  it  must  go  much  further 
than  this.     We  could  have  no  private  initiative  in  the  producing 
of  commodities,  unless  private  persons  were  allowed  to  own  the 
goods  from  which,  or  with  which,  commodities  are  produced. 

2.  Industrial  Freedom.     Since  cooperation  in  the  present  or- 
der is  not  consciously  organized  but  works  itself  out  through 
the  spontaneous  action  of  individuals,  freedom  of  action  for  in- 
dividuals is  plainly  an  essential  condition.     This  takes  various 
forms,   of   which   the    following   are   the   most   important:    (a) 
freedom  of  initiative,  the  right  to  start  enterprises  without  in- 
terference,  (b)  freedom  of  competition,  the  right  to  strive  for 
the  same  prizes  as  others  without  interference,  and  (c)  freedom 
of  contract,  the  right  to  enter  into  economic  engagements  with 
other  individuals  without  interference. 

ILLUSTRATIVE  PROBLEMS. 

1.  Distinguish  property  in  a  thing  from  possession  of  it. 

2.  Illustrate   in   detail   the  proposition   that   the   working   of 
the    present    economic    system    necessarily    involves    permitting 
private  persons   to  own  the  means   of  production. 

3.  Show  that  it  is  inconsistent  with  the  general  plan  of  the 
present  order  to  permit  producers  to   form   monopolistic  com- 
binations. 

4.  It  is  often  said  that  private  initiative  is  much  more  pro- 
gressive than  public  initiative  would  be.     Explain  in  simple,  lan- 
guage  what  is   meant. 

5.  Argue    for    the    proposition   that   we    could    not   have    an 
efficient  industrial  system  without  a  pretty  strong  government. 

Section  F.     Interference  with  the  Free  Automatic  Regulation  of 
Economic  Action  in  the  Interest  of  the  Group  Welfare. 

It  has  already  been  remarked  that  no  one  is  entirely  satisfied 
with  the  kind  and  degree  of  social  control  or  regulation  which 

25 


PRINCIPLES  OF  ECONOMICS 

is  effected  automatically  through  the  working  of  price.  Still  it 
is  probable  that  the  ge'neral  drift  of  this  chapter  is  in  support 
of  the  opinion  that  interference  is,  on  the  whole,  quite  undesir- 
able. It,  therefore,  seems  expedient  to  give  a  moment  to  the 
consideration  of  one  or  two  reasons  for  interfering  with  the 
automatic  control  of  economic  phenomena  which  have  received, 
and  perhaps  ought  to  receive,  considerable  acceptance.  In  this 
section,  we  remark  upon  this  interference  in  so  far  as  it  has 
for  its  particular  motive  the  securing  of  the  welfare  of  the 
group  as  a  whole,  the  country,  the  state,  the  city. 

The  fundamental  consideration  which  brings  this  particular 
case  to  the  front  is  that  there  is  a  possible  antithesis  betzveen 
the  welfare  of  the  individuals  constituting  a  group  and  the  group 
considered  as  a  whole.  If  the  world  consisted  of  one  nation 
homogeneous  in  ideals,  manners,  language,  and  so  on;  if  com- 
munication between  all  parts  were  perfectly  easy;  if  capital  and 
labor  were  perfectly  free  to  move  from  place  to  place;  if  we 
had  no  prejudices,  no  patriotism,  no  love  of  community  and 
neighborhood,  so  that  we  felt  perfectly  willing  to  change  resi- 
dence, there  would  be  a  much  readier  acquiescence  in  the  leav- 
ing of  all  economic  matters  to  automatic  regulation.  In  other 
words,-  the  free,  automatic  regulation  of  things  is  tfhe  ideal  of 
the  man  whom  we  should  describe  as  cosmopolitan  in  spirit, — 
one  who  is  interested,  or  thinks  he  is  interested,  in  all  humanity, 
and  has  almost  completely  gotten  rid  of  all  special  fondness 
for  any  particular  group  of  people  or  any  particular  country. 
But  such  a  description  would  apply  to  a  very  few  of  us  indeed. 
As  a  matter  of  fact,  almost  every  one  has  a  special  interest  of 
a  deep  and  abiding  character,  not  only  in  his  own  immediate, 
welfare  and  the  welfare  of  those  directly  dependent  upon  him,  but 
also  in  that  of  the  group  to  which  he  belongs, — the  city  or  state  or 
nation  of  which  he  is  a  member.  Love  of  country  is  just  as  natural 
a  passion  as  is  love  of  wife  or  love  of  children.  It  follows 
that,  if  any  group  of  men  come  to  believe  that  the  free,  automatic 
regulation  of  economic  relations  between  their  own  group  and 
other  groups  hinders  the  accomplishment  of  some  good  for  their 
group  which  they,  believe  to  be  of  great  importance,  they  will 
quite  naturally  and  properly  insist  upon  interfering  with  said 
automatic  regulation  of  things, — will  quite  naturally  and  properly 
insist  on  resorting  to  the  conscious  control  of  matters  through 
the  power  of  the  state.  For  example,  while  quite  ready  to  admit 
that  any  interference  with  trade  between  themselves  and  other 

26 


CHAPTER  I.  GENERAL  SURVEY 

countries  will  diminish  the  degree  to  which  cooperation  can  be 
carried  and  so  will  inevitably,  in  a  measure,  diminish  economic 
efficiency,  they  may  also  quite  naturally  believe  that  this  is  a 
comparatively  small  price  to  pay  for  advantages  which,  in  their 
opinion,  could  be  attained  by  some  degree  of  interference  and 
in  no  other  way.  Thus,  they  may  think  it  highly  desirable  that 
their  community  should  cease  to  be  a  pastoral  or  agricultural 
community  and  become  one  of  the  great  manufacturing  com- 
munities of  the  world;  and,  at  the  same  time,  they  may  believe 
that  they  can  contribute  to  bring  about  this  result  by  putting  up 
barriers  in  the  way  of  trade  with  other  countries.  They,  there- 
fore, urge  the  adoption  of  such  a  policy  in  spite  of  its  admitted 
disadvantages.  In  such  an  attitude  of  mind  and  in  such  a  policy, 
there  is  nothing  essentially  inconsistent  or  unreasonable.  Wheth- 
er, everything  taken  into  account,  it  is  justified,  is  a  question 
of  practical  judgment  upon  which  men  will  always  differ.  From 
the  standpoint,  of  the  economist,  the  chief  criticism  to  be  passed 
on  most  of  those  who  advocate  this  policy  of  restricting  trade, 
is  that,  in  their  zeal,  they  support  their  proposal  with  very  bad 
arguments, — arguments  which  ignore  the  inherent  advantages  of 
unrestricted  trade  as  permitting  a  high  degree  of  cooperation 
and  providing  for  its  effective  regulation. 

In  the  preceding  comment,  we  had  more  especially  in  mind 
the  case  of  a  country  as  a  whole  over  against  other  countries. 
It  hardly  need  be  said  that  the  same  problem  arises  in  the  rela- 
tions of  particular  sections  or  cities  within  a  country  to  other 
sections  or  cities  within  the  same  country.  Tlhus,  we  are  all 
familiar  with  the  popular  notion  that  it  is  the  duty  of  every 
community  to  protect  itself  against  the  competition  of  other 
communities,  e.g.,  that  it  is  the  duty  of  the  people  of  Ann  Arbor 
to  refrain  from  purchasing  goods  in  great  cities  and  thus  re- 
ducing the  business  of  home  dealers.  In  a  later  chapter,  it  will 
be  pointed  out  that  some  of  the  arguments  most  commonly  given 
for  this  policy  are  quite  fallacious.  But  this  must  not  blind  us 
to  the  fact  that  there  are  real  grounds  for  favoring  trade  with 
home  people  rather  than  outsiders,  e.g.,  the  desire  to  maintain 
for  our  own  convenience  a  particular  line  of  business  which  at 
the  best  has  difficulty  in  holding  its  own  against  outside  com- 
petition. In  this  case,  as  before,  the  wisdom  or  folly  of  the 
policy  favored  is  a  question  on  which  people  of  equally  good 
judgment  may  differ.  The  economist,  however,  must  try  to  in- 
sure that  fallacious  economic  arguments  be  eliminated  from  the 

27 


PRINCIPLES  OF  ECONOMICS 

controversy,  and,  at  the  same  time,  must  insist  that  all  inter- 
ference has  this  drawback,  viz.,  that  it  impairs  the  working  of 
that  mechanism  which  effects  and  regulates  our  economic  co- 
operation. 

ILLUSTRATIVE  PROBLEMS. 

1.  During  many  years  it  has  been  customary  for  a  particular 
Chicago   book   house   to    maintain    a   temporary   agency    for    the 
sale   of   text-books   in   the   city   of   Ann   Arbor   during  the   first 
few  weeks  of  the  college  year.     Give  one  or  more  reasons  for 
arguing  that  it  is  not  expedient  for  the  Ann  Arbor  citizen  or 
student  to  give  his  patronage  to  such  temporary  stores. 

2.  One  of  the   few  arguments  used  by  protectionists   which 
teachers  of  political  economy  would  recognize  as  sound  is  known 
as  the  Infant-Industries  Argument.     Develop  that  argument  with 
some  illustrations. 

3.  "Nothing  was  more  contrary  to  his    (O'Connell's)    desire 
than  that  her  (Ireland's)  population  should  be  greatly  diminished 
and  that  she  should  be  turned  into  a  great  pastoral  country,  yet 
nothing  is  more  clear  than  that  the  abolition  of  the  Corn  Laws, 
depriving   her   of  her   preferential   position    in   the   corn   market 
of  England,  made  such  a  change  inevitable."  Lecky's  Leaders  of 
Public    Opinion    in    Ireland,    volume   2,    pages   92-93,    quoted    by 
Dicey. 

(a)  What  is  meant  in  the  above  quotation  by  "her  prefer- 
ential position  in  the  corn  market  of  England"? 

(b)  Explain  why  one  might  perhaps  reasonably  expect  that 
the  adoption  of  free  trade  by  the  United  Kingdom  would  tend 
to  turn  Ireland  into  a  pastoral  country  with  a  diminished  popu- 
lation. 

Section  G.    Interference  with  the  Automatic  Regulation  of  Eco- 
nomic Action  Which  is  Intended  to  Promote  a  Different 
Distribution  of  Income. 

Another  very  important  type  of  interference  with  the  auto- 
matic regulation  of  economic  action  which  is  advocated  by  many 
persons,  has  as  its  object  the  changing  of  the  distribution  of 
income  among  citizens.  Schemes  of  this  sort  range  all  the  way 
from  some  slight  regulation  of  the  existing  system  in  respect 
to  matters  of  taxation,  up  to  schemes  which  completely  remodel 
the  existing  economic  order,  replacing  all  individual  initiative 
with  governmental  initiative  and  replacing  automatic  regulation 
with  conscious  regulation  by  the  state  itself.  The  advocacy  of 
schemes  of  this  sort  is  entirely  consistent  with  the  admission 
that  the  present  order  is  automatically  regulated  and  fairly  well 
regulated.  Further,  there  is  no  inherent  reason  why  any  one 

28 


CHAPTER  I.  GENERAL  SURVEY 

of  these  sdiemes  should  not  be  adopted,  if  it  promises  materially 
to  improve  the  present  order.  The  end  which  such  schemes 
set  before  themselves,  namely,  a  diminished  inequality  in  the 
distribution  of  income,  is  admitted  by  everyone  to  b.e  a  desirable 
end.  Further,  the  regulation  of  economic  matters,  like  all  other 
matters  within  society,  is  surely  within  the  prerogatives  of  the 
state.  The  only  question,  as  in  the  preceding  case,  is  one  of 
expediency.  The  fundamental  reason  for  the  maintenance  of  the 
present  system  of  spontaneous,  automatic,  control  is  the  belief 
that,  on  the  whole,  it  works  better  than  would  any  other  It  is 
not  maintained  because  society  has  no  right  to  set  up  a  different 
one.  On  the  contrary,  there  is  no  question  whatever  but  that, 
if  Michigan  or  the  United  States  or  England  or  Germany  thinks 
best  to  adopt  the  most  thoroughly  socialistic  or  communistic 
system  imaginable,  it  has  a  perfect  right  to  do  so.  If  society 
comes  to  believe  that  the  system  of  automatic  control  is  not, 
on  the  whole,  working  well,  it  will  be  the  business  of  society 
to  try  something  else.  One  point  only  the  economist  must  insist 
upon :  the  present  order  is  not  anardhic,  unregulated ;  it  is  auto- 
matically regulated,  and,  as  things  go  in  this  world,  fairly  well 
regulated.  Just  how  far  it  should  be  modified,  how  far  replaced 
by  a  new  system,  is  wholly  a  matter  of  practical  expediency, — 
a  matter  on  which  people  of  equally  good  judgment  must,  and 
will,  differ. 

Note :  It  is  largely  an  error  to  suppose  that  the  leading 
economists  of  the  first  half  of  the  last  century  held  opinions 
materially  different  from  those  just  given.  Almost  all  of  them 
were  not  only  able  thinkers,  but  also  men  who  were  thoroughly 
in  earnest  for  the  betterment  of  social  conditions.  They  advo- 
cated liberty,  non-interference,  laissez-jaire,  because  they  be- 
lieved that  such  betterment  of  social  conditions  was  to  be  se- 
cured only  by  this  policy; — and  there  can  be  no  material  doubt 
that,  for  the  time  and  place,  their  opinion  was  a  sound  one.  At 
the  same  time,  however,  they  did  not  hesitate  to  advocate  inter- 
ference when  they  believed  such  interference  demanded  by  ex- 
pediency. In  fact,  it  would  be  difficult  to  find  a  stronger  and 
better  statement  of  the  principle  that  there  is  no  proper  criterion 
as  to  the  legitimacy  of  any  particular  case  of  governmental 
interference  except  expediency,  than  is  to  be  found  in  Chapter 
I  Book  5  of  Mill's  Political  Economy,  which  was  published  in 
1848. 

ILLUSTRATIVE  PROBLEMS. 

i.  Point  out  some  cases  in  which  you  think  the  socialistic 
method  of  regulating  economic  activity  would  prove  more  desir- 
able than  the  present  one. 

29 


PRINCIPLES  OF  ECONOMICS 

2.  Point  out  some  cases  in  which  you  think  that  a  socialist 
system   would   almost   necessarily   have  to   keep   to   our   present 
method  of  automatic  regulation. 

3.  Try   to   get    some   admissions    from    socialists   that   -there 
would  be  points  at  which  automatic  regulation  would  be  inevit- 
able, even  under  their  system. 


30 


CHAPTER  II. 
ANALYSIS  OF  PRODUCTION. 

It  needs  very  little  reflection  to  convince  any  one  that  prac- 
tically all  economic  goods  of  the  sort  that  are  put  directly  to 
the  satisfying  of  wants,  as  also  the  great  majority  of  inter- 
mediate goods,  are  produced — result  from  the  action  of  men. 
It  is  hardly  necessary  to  say,  then,  that  one  important  topic  of 
economic  study  is  Production, — the  processes,  means,  and  con- 
ditions, by  which,  and  under  which,  men  bring  economic  goods 
into  existence.  We  must,  however,  note  at  the  outset  that 
economics  does  not  undertake  an  exhaustive  study  of  produc- 
tion. Much  the  largest  part  of  what  might  be  said  under  such  a 
head  is  relegated  to  technical  sciences  and  arts  such  as  Mining, 
Engineering,  Agriculture,  Mechanics,  and  so  on.  Economics 
limits  its  study  of  production  to  certain  most  general  aspects 
of  the  matter — especially  such  as  have  very  close  relations  to 
the  problems  of  value,  since, these  form  the  heart  of  economic 
science. 

Section  A.    The  Economic  Factors  of  Production. 

It  is  evident  on  the  least  reflection  that  to  produce  wealth, 
economic  goods,  involves  the  combined  operation  of  various 
elements  or  factors.  We  raise  potatoes  with  the  aid  of  land, 
fertilizers,  rain,  sunshine,  tools,  etc.  One  of  our  first  tasks  is 
to  isolate  the  different  factors,  decide  what  ones  are  economic, 
group  them  into  classes,  and  so  on.  In  doing  this  we  will 
analyze  commodity  production,  which,  being  more  complicated 
than  service  production,  fairly  covers  both  cases. 

1.     Surface    Account   of  the   Elements   or   Factors    Involved   in. 

Commodity  Production. 

Let  us  begin  by  setting  down  everything  we  can  think  of 
which  seems  necessary  to  the  production  of  some  manufactured 
article,  (a)  First,  plainly,  we  must  have  the  decision,  willing, 
of  some  person  to  produce ; — this  is  more  or  less  separable  from 
the  labor,  land,  etc.,  necessary,  as  seen  in  actual,  everyday, 

31 


PRINCIPLES  OF  ECONOMICS 

production,  (b)  Next  comes  a  place  for  the  producing  process, 
which  naturally  breaks  into  (1)  position  on  the  earth's  surface, 
(2)  a  specially  prepared  spot  of  ground,  and  (3)  a  building 
or  buildings,  (c)  Materials,  wood,  iron,  steel,  etc.,  are  neces- 
sary; and  these,  which  are  themselves  (1)  produced  materials, 
must  have  been  made  out  of  (2)  ultimate  materials,  (d)  Labor, — 
efforts,  physical  or  mental,  made  by  human  beings, — is  of  course 
indispensable,  (e)  Tools,  instruments,  must  be  available,  (f) 
Machines,  complex  tools  more  or  less  automatic  in  character, 
will  commonly  be  used,  (g)  Behind  these  machines  will  be 
prime-movers,  sources  of  power  such  as  the  steam  engine,  or 
water-power,  (h)  In  some  cases  these  will  require  fuel  or  feed. 
(i)  All  the  time  we  shall  be  using,  consciously  or  unconscious- 
ly, unappropriated  natural  powers  and  materials,  e.g.,  gravitation, 
heat,  light,  moisture,  air,  etc.  (j)  Finally,  producing  anything 
takes  time;  further,  the  producing  of  some  things  takes  more 
time  than  the  producing  of  other  things;  and,  most  of  all,  the 
producing  of  things  in  some  ivays,  requires  more  time  than 
producing  them  in  other  ways,  though,  once  the  longer  way  is 
started,  we  can  produce  better  and  faster  by  that  way.  In 
short,  production,  to  be  carried  on  in  accord  with  our  best 
interests,  requires  that  we  should  have  the  power  to  dispose  of 
time,  in  the  sense  o-f  being  able  to  choose  a  procedure  which 
requires  waiting  as  well  as  working.  (Read  pages  29  and  30 
of  the  Readings  and  show  that  the  use  of  the  more  efficient, 
but  also  more  roundabout,  methods  involves  the  possession  of 
waiting  power.) 

For  the  sake  of  denniteness,  let  us  make  a  list  of  these  in 
tabular  form. 

(a)  Conscious  willing  to  produce, — assembling  the  elements, 

etc., — assuming  the  responsibility  of  having  production 
go  on. 

(b)  Place. 

(1)  Position. 

(2)  Prepared  land. 

(3)  Buildings. 

(c)  Raw  Materials. 

(1)  Produced  Raw  Materials. 

(2)  Ultimate  Raw  Materials. 

(d)  Labor. 

(e)  Tools. 

(f)  Machines. 

32 


CHAPTER   II.     ANALYSIS    OF    PRODUCTION 

(g)   Prime  movers. 

(h)  Fuel  or  food. 

_(i)  Nature's  Powers  or  Materials  not  Embodied  or  con- 
trolled through  land  or  some  of  the^  things  above 
enumerated. 

(j)  Time. 

2.  The  List  of  Elements  or  Factors  of  Production  Revised  and 

Grouped  on  the  Basis  of  a  Deeper  Analysis. 
It  is  hardly  necessary  to  say  that  no  thoughtful  person  would 
be  satisfied  with  the  above  strictly  surface  account  of  the  factors 
involved  in  production.     Some  deeper  analysis  and  grouping  is 
surely  needed. 

(a)  In  the  first  place,  the  elements  grouped  under  (i),  those 
powers  or  materials  of  nature  which  are  not  controlled  through 
land  or  machines  of  prime  movers,  e.g.,  the  air, — nitrogen  in  the 
air,    moisture,    etc.,    though    necessary    to    production,    are    not 
accounted  economic  factors  at  all,  for  the  reason  that  they  are 
not  controllable  or  appropriable,  therefore,  do  not  have  value, 
therefore   do   not  belong   in  the    economic   field.      Elements   of 
this  class  are  physical  or  technical  factors  of  production  but  not 
economic  factors.* 

(b)  Again,  land  which  is  actually  being  used  in  production 
is  not  necessarily  a   true  economic  factor.     In  partially  settled 
countries,    anyhow,    there    will    often    exist    a    state    of    things 
wherein  some  of  the  land  actually  in  use  is  no  more  desirable 
than  much   which  is  not  in  use  and  has  no  value  because  of 
this  abundance  of  its  kind  of  land.    Under  these  conditions,  the 
particular  piece  of  land  actually  being  used  is  not  an  economic 
factor.     This   of   course   does   not   mean   that  the   potatoes   or 
wheat  raised  on  the  land  in  question  could  be  raised  without 
land ;   but   merely   that,   under   the   circumstances,   none   of   the 
product  is  credited  to  the  land,   since  plenty  other  pieces  just 
as  good  could  be  substituted  for  this  particular  piece  without 
costing  anything,  and  so  the  land  factor  in  this  case  is  virtually 
a  free  good  like  the  air  or  the  nitrogen  or  the  moisture  which 
figured  in  the  preceding  case.f 

*Notice  that  a  thing  may  be  a  technical  factor  but  not  an  economic 
one.  The  converse,  however,  is  not  true.  Nothing  can  be  an  economic 
factor  which  is  not  first  a  technical  factor.  If  any  element  is  essential 
to  the  result,  it  is  a  technical  factor.  If,  in  addition,  it  comes  into  the 
economic  field  as  a  thing  which  has  value,  it  is  an  economic  factor. 

•f-The  simplest  test  of  an  economic  factor  is  the  presence  or  absence  of  value 
ralue. 

33 


PRINCIPLES  OF  ECONOMICS 

(c)  The  preceding  two  paragraphs  have  thrown  out  from  the 
list  of  economic   factors   some    elements   of  natural   origin,   air, 
nitrogen,  and  even  land  under  some  conditions.     But  some  of 
nature's    contribution    are    surely   economic.     The   ultimate    raw 
materials,    (c)    (2),  often  have  value,  because  relatively  scarce, 
and  so  must  be  accounted  economic  factors.     So,  land,  as  posi- 
tion on  the  earth's  surface,   (b)    (1),  though  not  necessarily  an 
economic  factor,  is  usually  such,  being  scarce  and  having  value. 
This    factor   we    might    call    "nature;"    but    more   usually   it   is 
designated  land,  meaning,  remember,  the  original,  unproducible, 
indestructible,  earth, — including  ultimate  raw  materials, — together 
with  such  produced  elements  as,  under  various  conditions,  come 
to  behave,  in  the  determination  of  values,  as  if  they  were  an 
original  part  of  the  earth. 

(d)  Labor,  the  element  numbered   (d)   in  our  table,  is  ob- 
viously a  technical  factor  in  production, — without  it  production 
can  not  go  on.    Further,  as  we  all  know,  it  is  also  an  economic 
factor, — it  has  value,  belongs  to  the  economic  field.    According- 
ly, every  one  recognizes  it  as  being,  anyhow,  one  of  the  ultimate 
productive  factors. 

(e)  Looking,  now,  at  the  remaining  factors  in  our  list,   we 
note  that  all  but  two    of   them  will   naturally  go   together   as 
being  themselves  products,  though  products  which  are  wanted, 
not   for  their   own   sakes,   but    for   the   sake   of   something    we 
expect  to   make    out   of  them.     Here   we    should   have   to   put 
(b)    (3),   (c)    (1),   (e),   (f),   (g),  and   (h).    With  these  should 
be  reckoned  (b)    (2), — though  this  is  not  quite  so  plain, — since 
prepared  land,  looked  at  as  prepared,  is  "produced  just  as  much 
as  is  pig  iron  or  ingot  copper.     Let  us  for  the  moment  name 
this  group  intermediate  products. 

(f)  We    have    now    only    two    undistributed    elem/ents    on. 
our    list:      time    and    willing     to    produce.      What    is    to    be 
done    with    the     former?      At    first    thought,    one    might    be 
disposed    to    say    that    time,    however    necessary    to     produc- 
tion,   car.    not   be    an    economic    factor    because    it    can    not    be 
bought  and  sold.    But  we  must  not  be  too  hasty.    In  effect,  time, 
or  waiting  power,  is  bought  and  sold,  every  day.    The  need  for 
time  in  order  to  resort  to  more  efficient  methods  naturally  ex- 
presses itself  in  the  need  for  surpluses  of  those  goods  which  we 
are  now  producing,   in  order  that  we  should  be  able  to  turn 
some  portion  of  our  efforts  into  the  new  channel.     In  short, 

34 


CHAPTER   II.     ANALYSIS    OF    PRODUCTION 

we  must  have  something  ahead.  Now,  this  getting  something 
ahead  can  be  done,  so  to  speak,  by  proxy.  Some  persons  whose 
incomes  make  it  possible,  save  from  those  incomes  and  accumu- 
late stocks  of  money  or  money  credit.  These  accumulations 
embody,  we  may  say,  waiting  power,  time.  The  responsible 
producer  borrows  them  and  then  hires  labor  to  initiate  the 
round-about,  time-consuming,  methods.  In  thus  borrowing,  he 
is  in  effect  buying  time,  waiting  power ;  and  the  lender  is  selling 
such  time  or  waiting  power.  Accordingly,  in  our  present  eco- 
nomic order,  time,  as  an  economic  factor,  manifests 'itself  in  the 
shape  of  loanable  money  funds.  These  the  business  world 
usually  denominates  capital;  and  we  will  for  the  moment  accept 
this  designation. 

(g)  We  have  now  but  one  of  our  items  left,  viz.,  (a), 
willing  that  production  go  on,  assuming  the  responsibility  of 
having  things  produced.  At  first  thought,  the  setting  up  of  this 
element  as  a  separate  factor  seems  hardly  less  than  absurd. 
Surely  no  one  can  produce  without  willing  to  produce,  assum- 
ing the  responsibility  of  producing.  Does  not  every  one  who 
makes  any  contribution  to  the  productive  process  in  so  far  will 
the  existence  of  the  product?  This  sounds  plausible;  but  it  will 
not  stand  examination.  The  patent  fact  of  experience  is  that 
the  assuming  of  responsibility  for  the  product's  existence  is  a 
function  which  is  separated  from  the  several  contributions 
necessary  to  the  result.  The  men  who  supply  land  services, 
labor  services,  and  capital  services,  respectively,  leave  to  some- 
one who  buys  these  services  from  them  the  bearing  of  respon- 
sibility for  results.  He  wills  those  results;  bears  the  anxieties; 
and  suffers  the  losses. 

(h)  The  preceding  analysis  has  left  us  provisionally  five 
factors,  land,  labor,  intermediate  goods,;  money  capital,  and 
responsibility-taking.  But  some  further  revision  and  con- 
centration is  necessary.  The  third  of  these  five  elements,  inter- 
mediate goods,  being  themselves  products,  must  be  in  some 
sense  and  degree  mere  embodiments  of  previous  elements  or 
factors.  That  is,  it  does  not  seem  as  if  they  could  be  said  to 
constitute  an  original,  independent,  factor  coordinate  with  land 
and  labor.  Ought  we  not,  then,  to  drop  this  class  out  alto- 
gether, affirming  with  the  socialist  that  such  goods  are  merely 
"congealed  labor"  or,  anyhow,  that  thev  are  congealed  land  and 
labor?  To  this  question,  most  economists  more  or  less  clearly 

-35 


PRINCIPLES  OF  ECONOMICS 

give  a  negative  answer.  We  must  treat  these  intermediate 
goods  as  an  independent  factor,  because  they  embody  another 
element  besides  land  services  and  labor  services,  viz.,  waiting, 
time.  We  do  not  adequately  describe  the  matter  when  we  say 
that  the  fisherman  who,  instead  of  catching  fish  directly  with 
his  hands,  begins  by  making  a  net  and  then  uses  the  net  to 
catch  fish,  is  merely  working  on  a  different  plan  from  what  he 
would  in  the  other  case.  Such  language  suggests  that  the  sac- 
rifices are  absolutely  equal  in  the  two  cases,  that  all  the  con- 
ditions requisite  in  the  "net"  method  could  be  fulfilled  by  any 
one  who  could  fulfil  those  requisite  in  the  "hand"  method, — 
assuming  that  he  could  make  nets  as  well  as  use  them.  But,  of 
course,  such  a  statement  would  be  quite  untrue.  The  fisherman 
who  has  enough  dried  fish  ahead  so  that  he  can  devote,  say, 
30  days  to  making  a  net,  can  resort  to  the  "net"  method.  In 
contrast,  the  fisherman  who  has  nothing  to  satisfy  his  hunger 
beyond  today  must  be  content  with  the  "hand"  method,  even  if 
he  has  just  as  much  skill  in  net-making  as  his  rival.  That-  is,  in 
order  to  be  able  to  use  roundabout  methods,  to  begin  by  making 
intermediate  goods  and  then  use  these  to  reach  our  true  goal,  it 
is  necessary,  not  merely  that  one  be  able  to  labor  in  the  ordi- 
nary sense,  but  also  that  he  have  the  power  to  wait.  If  some 
one  wishes  to  insist  that  this  is  only  a  special  phase  of  labor, 
he  surely  has  the  right  to  use  such  language, — though  the 
notion  seems  rather  ridiculous  in  view  of  the  fact  that  this 
phase  of  labor  is  mostly  performed  by  the  very  people  who  do 
little  or  no  labor  in  the  usual  sense.  But,  whatever  some  per- 
sons choose  to  call  it,  this  element  is  surely  present  in  inter- 
mediate goods,  and,  to  the  ordinary  mind,  it  is  not  covered  by 
the  word  labor.  Accordingly,  it  is  necessary  to  insist  that  the 
intermediate  goods  now  under  consideration  are  embodiments, 
congelations,  of  land  services,  labor  services,  and  waiting.  They, 
therefore,  have  to  be  distinguished  as  constituting,  in  some  sense 
and  degree,  a  factor  independent  of  land  and  labor. 

In  the  foregoing  paragraph  we  have  insisted  that  interme- 
diate products  must  be  recognized  as  an  independent  factor. 
But  the  particular  feature  of  these  intermediate  products  which 
was  used  to  defend  our  position,  viz.,  that  they  embody  waiting, 
was  also  provided  for  under  the  fourth  provisional  element, 
money  capital, — surplus  money  funds  devoted  to  the  purchase  of 
these  very  intermediate  products.  Now,  it  is  obvious  that  we 

36 


CHAPTER  II.    ANALYSIS  OF  PRODUCTION 

must  not  count  this  waiting  element  twice.  Further,  it  is 
hardly  less  obvious  that  there  would  be  little  propriety  in  dis- 
tinguishing waiting  power  as  embodied  in  money  funds  from  such 
power  when  embodied  in  ordinary  intermediate  goods.  In  short, 
the  seemingly  reasonable  procedure  is  to  coalesce  our  third  and 
fourth  elements  into  one — capital ;  and  this  is  the  universal 
practice  where  either  is  kept  distinct  from  land  or  labor. 

We  have  now  reduced  our  factors  to  four,  land,  labor,  capital, 
and  responsibility-taking.  Ought  we  to  take  another  step,  com- 
bining the  third  and  fourth  into  one,  and,  thus,  reducing  all  to 
land,  labor,  and  capital?  Is  not  the  assuming  of  the  respon- 
sibility for  production  simply  one  aspect  of  the  function  of 
capital?  or  anyhow  one  function  of  capital  coordinate  wth  the 
other  function,  waiting?  Responsibility-taking  obviously  goes 
along  with  being  the  owner;  and  is  that  not  true  of  waiting? 
Is  not  the  lending  capitalist  virtually  a  part  owner  of  the  busi- 
ness and  its  outfit?  This  doubtless  has  much  force.  We 
should  not  be  far  astray  in  holding  that  the  factors  of  produc- 
tion are  three:  land,  labor,  and  capital.  If  we  do  this,  how- 
ever, we  must  not  forget  that  capital  performs  in  the  process 
two  functions,  waiting  and  responsibility-taking,  and,  in  actual 
practice,  these  are  to  a  considerable  extent  separated.* 

3.  Should    the    Factors    of    Production   be    Reduced   to 

Two  or  One? 

The  foregoing  analysis  of  the  productive  process  has  left 
us  with  four,  or  anyhow  three,  economic  factors  of  production. 
Against  this  account  of  the  matter,  which  may  be  described  as 
the  conventional  or  orthodox  one,  there  has  been,  and  still  is, 
more  or  less  opposition.  Some  would  reduce  the  factors  to 
land  and  labor;  some,  to  capital,  and  labor;  some,  to  labor 
alone.  The  first  of  these  opposing  doctrines  has  already  been 
more  or  less  fully  dealt  with  in  the  preceding  division  of  this 
section.  The  principal  ground  on  which  is  maintained  the  con- 
tention that  land  and  labor  cover  the  whole  case,  is  that  capital 

*It  is  worth  the  student's  while  to  note  that  this  and  many  other 
points  in  economic  analysis  which  seem  to  outsiders  needlessly  subtle  are 
after  all  only  careful  theoretic  expressions  of  distinctions  which  have  long 
been  embodied  in  business  practice.  In  that  practice,  the  borrowing 
producer  largely  gets  rid  of  the  waiting  part  of  the  capitalistic  burden 
by  borrowing,  while  he  retains,  in  large  measure  anyhow,  the  responsibility 
burden.  He,  not  the  lending  capitalist,  does  the  worrying,  make  the 
final  decisions  with  respect  to  the  conduct  of  the  business,  and  suffers  tha 
loss  if  failure  comes. 

37 


PRINCIPLES  OF  ECONOMICS 

— intermediate  go'ods — is  produced  by  the  combining  of  land 
and  labor  and,  so,  is  not  an  independent  factor,  coordinate  with 
those  two.  The  inadequacy  of  this  reasoning  has  already  been 
explained:  capital  contains  another  element  besides  those  which 
are,  or  can  be,  furnished  by  land  or  labor,  using  those  terms  in 
any  natural  or  usual  sense ; — to  secure  capital  man  must  have  at 
his  disposal  waiting  power  as  well  as  labor.  We  can  not,  there- 
fore, rest  satisfied  with  an  analysis  which  reduces  the  factors  of 
production  to  land  and  labor.  Capital  must  be  recognized  as  in 
some  sense  and  degree  an  independent  factor.* 

We  have  seen  that  some  economists  deny  the  right  of  cap- 
ital to  be  considered  an  independent  factor  in  production.  An- 
other group  admit  the  claims  of  capital  but  deny  those  of  land. 
Land,  in  their  view,  is  only  a  particular  kind  of  capital;  and,  so, 
the  factors  of  production  are  labor  and  capital.  Now,  there  are 
no  doubt  reasons  for  uniting  land  and  capital  (as  heretofore 
used)  under  one  designation.  The  two  things  have  some  ele- 
ments in  common.  But,  for  that  matter,  so  do  land,  capital,  and 
labor ;  and  more  than  one  recent  writer  has  reduced  all  the 
factors  of  production  to  one, — capital.  In  fact,  all  analysis  is 
more  or  less  arbitrary.  Everything  which  exists  is  in  some  kind 
and  degree  similar  to,  and  connected  with,  everything  else  whch 
exists.  Winding  in  and  out,  there  are  innumerable  threads  con- 
necting one  concept  with  another ;  so  that,  wherever  we  put  the 
dividing  line,  we  shall  cut  some  real  connections.  Biologists 
have  never  agreed  on  any  perfectly  adequate  method  of  dis- 
tinguishing animal  and  vegetable  organisms.  Within  a  fortnight 
(1911)  I  have  been  told  by  a  professor  of  biology  that  he  should 
not  be  surprised  to  hear  almost  any  time  that  some  one  had 
proved  the  existence  of  consciousness  in  the  particles  of  the 

*It  will  perhaps  occur  to  the  student  that  we  ought  to  mean  by 
capital,  not  the  whole  engine  or  net  or  car,  but  only  some  part,  some 
feature,  of  it, — the  waiting  element  in  it  as  distinguished  from  the  land 
and  labor  elements.  This  is  surely  in  a  way  reasonable;  and  it  is  not 
improbable  that  more  than  one  of  the  somewhat  startlingly  novel  ways 
of  conceiving  and  defining  capital  which  have  appeared  in  recent  years 
have  their  origin  in  a  more  or  less  conscious  attempt  to  carry  out  this 
idea.  Much  stress  is  laid  on  the  waiting  idea,  or  on  the  time  idea.  The 
teacher  of  economics  who  is  not  prepared  to  go  so  far  as  to  adopt  a 
totally  new  definition  of  capital,  nevertheless  often  permits  himself 
figurative  forms  of  expression  which  bring  out  the  same  idea.  Thus,  he 
may  perhaps  describe  capital  as  waiting  power,  bottled  time,  etc.  But 
all  such  methods  of  treating  the  matter,  if  taken  literally,  meet  one  very 
serious  difficulty:  the  peculiar  element  which  characterizes  capital  as 
capital  is  separable  from  the  others  only  by  a  very  heroic  abstraction  which 
many  find  it  difficult  to  use  without  giving  it  a  concreteness  to  which  it 
has  no  claim. 

38 


CHAPTER   II.     ANALYSIS    OF    PRODUCTION 

huge  boulder  which  constitutes  the  memorial  of  the  class  of  '62.- 
In  general,  then,  all  lines  of  demarcation  must  be  illogical  in  the 
sense  that  they  separate  some  things  which  have  much  in  com- 
mon and  put  together  some  things  which  show  radical  differ- 
ences. The  choice  of  the  proper  point  of  division  is,  therefore,  a 
matter  of  expediency  in  view  of  all  the  facts  of  the  case.  Usage 
counts  for  a  considerable;  significance  in  connection  with  great 
practical  problems  counts  for  much  more.  In  the  opinion  of 
most  economists,  the  behavior  of  land  (in  the  economic  sense) 
in  respect  to  the  determination  of  values,  and  so  in  respect  to 
various  practical  problems  in.  which  value-determination  is  of 
prime  importance,  is  sufficiently  different  from  that  of  ordinary 
forms  of  capital  — intermediate  products — to  make  the  distin- 
guishing of  the  two  in  many  cases  highly  desirable.  Until  that 
opinion  is  changed,  economists  will  not  consent  to  throw  out 
land  as  an  independent  factor  in  production  merely  because  a 
scholastic  logic  can  find  reasons  for  treating  land  and  capital 
as  one.* 

It  may  perhaps  help  the  student  at  this  point  to  be  told  that, 
by  universal  admission,  the  "land"  of  orthodox  economics  is 
seldom  if  ever  physically  separated  from  capital.  Yet  the  sep- 
arateness  of  land  is  not  a  mere  abstraction.  Land  more  or  less 
completely  separates  itself  from  the  capital  associated  with  it  in 
the  processes  of  price  determination.  Thus,  under  normal  con- 
ditions, if  the  government  levies  a  tax  on  buildings  this  causes 
the  hire  (rent  in  the  popular  sense)  of  such  buildings  to  rise; 
while,  if  the  government  puts  its  tax  on  the  site,  this  does  not 
cause  the  hire  of  the  site  to  rise,  but  does  cause  the  price  of  the 
site  to  fall.  It  must  be  admitted  that  this  economic  separation 
of  the  producible  and  non-producible  constituents  is  often  im- 
perfect,— that  some  of  the  produced  elements  get  inextricably 
tangled  up  with  the  non-producible — ;  but  this,  it  would  seem, 
could  invalidate  our  distinction  only  on  condition  that  the  par- 
ticular producible  elements  under  consideration  were  able  to 
draw  the  non-producible  ones  over  into  their  class,  in  other 
words,  to  obliterate  the  distinction.  But  this  surely  does  not 
happen.  Instead,  these  particular  producible  elements  have  to 
give  up  all  connection  with  their  own  kind,  have  to  come  under 
the  dominion  of  the  economic  laws  governing  non-producible 
elements. 

We  have  remarked  on  those  objections  to  the  conventional 
analysis  of  production  which  would  reduce  the  factors  either 
(1)  to  land  and  labor  or  (2)  to  capital  and  labor.  There  re- 


See  note  at  end  of  volume,  page 
39 


PRINCIPLES  OF  ECONOMICS 

mains  the  objection  which  seems  to  reduce  them  to  one,  labor. 
It  is  probable  that  this  way  of  looking  at  the  matter  is  no 
longer  of  much  significance.  It  seems,  however,  to  have  had 
more  or  less  vogue  among  socialists  and  semi-socialists.  This, 
of  course,  does  not  mean  that  any  socialist  would  claim  that 
labor  can  produce  without  nature's  assistance,  or  can  produce 
effectively  without  the  assistance  of  capital.  The  latter  factor, 
however,  was  quickly  disposed  of  by  insisting  that  it  is  only 
congealed  labor.  Land  was  got  rid  of  in  another  way.  It  is, 
of  course,  necessary  and  it  is  not  a  form  of  labor.  But  it  is  a 
free  good,  i.e.,  a  gift  of  nature.  Under  the  present  order,  it 
has  an  economic  character  and,  so,  is  an  economic  factor.  But 
this  economic  character  is  given  to  it  arbitrarily  by  permitting 
property  in  it; — men  are  permitted  to  own  it,  hence  to  give  it 
value,  and,  so,  to  make  it  an  economic  factor.  It  is  probable  that 
few  enlightened  socialists  of  our  day  would  support  this  con- 
tention. Its  unsoundness  is  easily  shown.  Ownership  is  essen- 
tial to  exchange  value;  but  mere  ownership  can  not  give  such 
value.  There  must  be  scarcity  as  well.  If  there  is  monopolistic 
ownership,  then  the  needed  scarcity  can  be  secured  artificially ; 
and,  so,  the  economic  character  given  to  a  thing  may  be  arbi- 
trary in  its  nature.  But  the  ownership  of  land  is  not  usually 
monopolistic, — there  are  many  competing  owners.  The  value 
of  land  is,  therefore,  not  arbitrary,  but  perfectly  natural,  in  its 
origin.  Under  socialism,  land  would  have  value  and,  so,  would 
be  an  economic  factor  just  as  truly  as  now;  only,  under  social- 
ism, the  owner  of  the  land  would  be  the  state  rather  thsn  the 
individual ;  and,  so,  the  share  of  tihe  land  in  production  would 
be  credited  to  the  state  rather  than,  as  now,  to  private  individu- 
als. 

4.  Relations  of  the  several  Factors  of  Production  to  one  another. 
It  is  very  plain  that  the  most  vital,  central,  element  in  the 
producing  process  is  assuming  the  final  responsibility  for  it, 
willing  that  production  shall  take  place  and  exercising  final 
authority  in  its  conduct.  It  follows,  therefore,  that  capital 
viewed  as  the  factor  on  which  responsibility-taking  falls,  is  the 
primary,  central,  factor  in  production,  as  it  is  conducted  in  a 
highly  developed  industrial  society.  The  entrepreneur,  as  he  is 
now  commonly  called,  the  one  who  is  responsible  for  the  ex- 
istence of  the  business,  is  the  producer  par  excellence.  All 
others  engaged  in  the  undertaking  are  naturally  conceived  as 

40 


CHAPTER  II.  ANALYSIS  OF  PRODUCTION 

auxiliaries,  as  producers  of  services  which  the  entrepreneur 
assembles,  combines,  into  that  commodity  which  is  the  product 
•of  the  business  taken  as  a  whole. 

ILLUSTRATIVE  PROBLEMS. 

1.  "Here  is  a  country  with  abounding  natural  resources  and 
.an  energetic  and  industrious  population ;  but  its  development  is 
impeded  by  the  lack  of  capital.     Measures  should  be  taken  to 
draw   in   the   surplus    capital   of   England   and   other   European 
countries." 

Explain  more  fully  and  with  illustrations  what  the  first 
sentence  means. 

2.  "The  most  of  us  live  by  our  wits — spend  our  time  wheed- 
ling the  true  producers,  the  men  who  work  with  their  hands, 
into  sharing  with  us  the  things  which  they  produce." 

Give  several  illustrations  of  kinds  of  labor  necessary  to  pro- 
duction which  would  not  naturally  be  described  as  working  with 
one's  hands. 

3.  How  ought  the  fences  on  a  farm  to  be  classed,  as  land 
or  capital?    How  about  the  tile  drains?    The  trees  in  the  wood 
lot?     The  trees  in  a  young  apple  orchard?     Does  it  prove  that 
a  given   distinction  is  illegitimate  or  useless  to  show  that  you 
•could  not   draw  that   distinction   in   every  actual   case?      Illus- 
trate this  point. 

4.  Argue  for  the  propriety  of  the  statement  that  capitalistic 
production  is  round-about  production. 

5.  Some  writers  have  been   disposed  to   affirm  that,  in  the 
last  analysis,  all  capital  gets  its  start  in  a  surplus  of  the  means 
of   subsistence,    particularly   food.     This   undoubtedly   has    con- 
siderable force  as  applied  to  primitive  conditions.     Illustrate  the 
proposition  for  a  community  of  fishermen. 

6.  Josiah  Wright,  the  wagon  maker,  is  making  a  stone  boat 
which  he  expects  to  sell  to  some  neighboring  farmer.     Now,  a 
stoneboat  is  undoubtedly  capital  or  capital  goods ;  yet  in  making 
that  stoneboat,  Wright  is  not,  strictly  speaking,  producing  cap- 
ital.    Explain  the  riddle. 

7.  "Discovery    and   invention   have    doubtless    played    a   very 
large  part  in  securing  our  present  high  industrial  efficiency.    But 
they  are  not  the  whole  thing.     The  increase  of  capital  has  been 
equally   necessary ;    for,    without   capital,    invention    could    have 
accomplished  little  or  nothing."     Defend  and  illustrate  the  last 
sentence. 

8.  "The   common   pursuit   of   forestry  as   a   private  business 
almost   had  to  wait  until   capital   became   relatively   very   abun- 
dant."   Why  should  this  be  true  of  forestry  more  than  of  wheat 
raising? 

9.  The   following   is   taken   from   a   short   story  in  a   recent 
number  of  one  of  the  popular  magazines.     The  hero  inherited 

41 


PRINCIPLES  OF  ECONOMICS 

great  wealth  in  rolling  mills  and  has  for  several  years  success- 
fully continued  the  business.  He  is  also  public-spirited  and  lib- 
eral. Referring  to  his  charities,  the  author  says:  "What  was  it 
that  he  had  given?  Something  that  he... had  never  earned. 
His  hands  had  never  touched  belt  or  pulley.  He  looked  at 
them  curiously.  It  was  the  toil-hardened  hands  of  twelve  hun- 
dred other  men  that  made  his  giving  possible — the  hands  of  the 
men  he  was  planning  to  turn  off  on  Monday." 

Show  that,  if  this  was  a  normal  case,  we  could  impute  to 
the  services  of  the  twelve  hundred  workmen  only  a  part  of  the 
net  output  of  .the  mills ;  that  the  portion  going  to  the  proprietor 
was  reasonably  enough  credited  to  his  contribution  to  the  busi- 
iness.  Enumerate  several  elements  which  probably  entered  into 
his  contribution. 

Section  B.    The  Agents  (Actors)  in  Production 

The  preceding  analysis  of  the  productive  process  is  an 
economic  analysis,  the  factors  brought  out  are  economic  factors, 
i.e.,  factors  which  are  embodied  in  material  objects  or  condi- 
tions controlled  by  human  beings  and  having  value.  The  con- 
trol of  these  several  factors  is,  or  at  least  may  be,  in  the  hands 
of  different  classes  of  persons.  It  follows,  therefore,  that  there 
are  different  classes  of  producers,  different  agents  or  actors  in 
production,  corresponding  to  these  factors.  This  matter  has, 
of  course,  been  already  anticipated,  but  a  more  explicit  analysis 
is  demanded. 

1.  The  primary,  central,  factor  in  production  is  capital, 
viewed  as  the  responsibility-taking  element;  and  so,  of  course, 
the  primary,  central,  agent  in  production  is  the  person,  natural 
or  legal,  who  supplies  this  factor,  who  assumes  the  function  of 
3..  responsibility-taking.  Adam  Smith  (1776)  called  him  the  un- 
dertaker. For  obvious  reasons  this  very  desirable  usage  is  out 
of  vogue.  In  its  place  most  English-speaking  writers  employ 
French  equivalent,  entrepreneur.  Recently  some  writers 
ive  taken  to  using  a  newly-coined  term,  enterpriser. 

Notes:  (a)  One  who  performs  the  function  of  responsibility- 
taking  with  respect  to  an  old  business  is  just  as  truly  an  entre- 
preneur as  one  who  occupies  the  same  relation  to  a  new  busi- 
ness. Every  business,  old  or  new,  must  have  an  entrepreneur. 
This  forms  a  decisive  objection  to  the  statement  sometimes 
made  that  profit — the  remuneration  of  the  entrepreneur — is  the 
reward  or  wages  of  enterprise,  i.e.,  taking  the  risk  and  general 
responsibility  of  starting  new  undertakings.  It  is  also  something 
of  an  objection  to  the  name  "enterpriser",  since  this  suggests, 
not  the  entrepreneur  as  such,  but  a  particular  class  of  entre- 

42 


CHAPTER   II.     ANALYSIS    OF    PRODUCTION 

preneurs,  viz.,  those  who  show  enterprise — courage — in  starting 
new  undertakings. 

(b)  The  student  should  be  careful  to  distinguish  the  entre- 
preneur of  a  business  from  the  promoter,  the  man  who  induces 
people  to  start  it. 

(c)  It  is  an  error  which  in  our  day  is  very  obvious  to  make 
the  managing  of  a  business  the  peculiar  function  of  the  entre- 
preneur, though  not  a  few  economists  have  made  this  mistake. 
The   decisive  consideration   is   that  many  entrepreneurs   almost 
entirely   hire   their   managing  done,   just  as   they  hire   stoking, 
engineering,  book-keeping,  etc.,  done ;  and,   so,  managing  takes 
its  place  as  one  of  the  many- kinds  of  labor  necessary  to  a  busi- 
ness, and  the  men  who  do  it  are  only  a  higher  sort  of  laborers. 
It  should  be  noted,  however,  that  there  almost  necessarily  re- 
mains to  the  entrepreneur  a  residuum  of  managing; — he  must 
usually  make  final  decisions  with  respect  to  certain  fundamental 
policies,  and  he  must  at  least  choose  one  or  more  leading  mem- 
bers of  the  managerial  force. 

(d)  It  follows  from  the  last  sentence  that  they  are  some- 
what at   fault  who  make   risk-taking  the   sole   function  of  the 
entrepreneur.     Doubtless  the  taking  of  risk  is  one  of  the  most 
conspicuous  features  of  final-responsibility-taking;  but  it  is  not 
the  only  one. 

(e)  In  the  case  of  industries  undertaken  by  corporations,  the 
corporation    as   such,   that  is,   the   collective  unit,    is,    from   the 
standpoint  of  formal  logic,  the  true  entrepreneur.     But  caution 
in    interpretation    is    here    necessary.      The    corporation    acting 
through  its  usual  organs,  president,  secretary,  general  manager, 
etc.,  can  not  be  the  entrepreneur;  since  these  organs  are  created 
by  a  more  fundamental  power,  the  board  of  directors.     Again, 
the  corporation  acting  through  the  board  of  directors,  can  not 
be  the  real  entrepreneur ;  since  that  body  is  created  by  a  more 
fundamental  power,  the  general  meeting  of  stockholders.    When 
at  last  we  reach  the  general  body  of  stockholders,  acting  in  the 
way  prescribed  by  their  charter  for  the  determination  of  funda- 
mental questions,  we  are  in  the  presence  of  something,   which 
from  some  standpoints,  may  fairly  be  called  ultimate, — there  is 
nothing  behind  to  determine  its  action.     This  general  body  of 
stockholders,  therefore,  may  put  up  a  fairly  good  claim  to  the 
title  of  entrepreneur.     In  a   sense,  however,   the   function   and 
title  seem  in  some  respects  to  fall  on  stockholders  as  a  mere 
aggregate.    This  is  particularly  true  at  the  starting  of  corporate 
undertakings.     Whether  or  not  the  industry  shall  be  carried  on 
at  all,  i.e.,  the  taking  of  the  ultimate  responsibility  of  produc- 
tion,  rests   with   investors   as  individuals,   not   with   a   body   of 
stockholders    formally  organized.     Accordingly,    for   some   pur- 
poses, we  have  to  locate  the  entrepreneur  of  a  corporation  in 
the  stockholders  formally  organized,  while,  for  other  purposes, 
we  look  on  the  mere  aggregate  of  stockholders   as  occupying 
this  position. 

43 


PRINCIPLES  OF  ECONOMICS 

2.  Besides  capital,  serving  as  the  responsibility-taking  factor, 
we  will  remember  that  there  are  three  other  factors,  land,  labor, 
and    capital    considered    as    the    factor    which    supplies    waiting 
power.    These  three,  as  already  indicated,  may  be  conceived  as 
subordinate  to  capital  viewed  as  the  responsibility-taking  factor. 
For  each  of  these,  there  is  of  course  a  corresponding  agent  or 
actor.     The  agent  in   the  case   of  land  is  the  land  owner  or 
landlord.    He  is  the  one  who  furnishes  the  use  of  the  land  or 
land  services. 

As  hinted  in  another  place,  it  is  possible  to  have  an  economic 
order  in  which  private  land  owning  is  not  permitted,  and  there- 
fore one  in  which  the  private  landlord  would  not  be  a  producer, 
an  agent  in  production.  But  it  has  not  been  possible  since  the 
very  beginning  of  society  to  have  an  order  in  which  some  sort 
of  landlord  would  not  be  an  agent  in  production.  For,  just  as 
soon  as  any  part  of  this  land  came  to  be  wanted  by  more  than 
one  person,  it  would  come  to  have  value,  would  become  an 
economic  good.  Some  one  would  inevitably  appropriate  it  and 
take  advantage  of  its  superior  desirableness.  This  might  be 
the  community  as  a  whole  or  an  individual.  And,  whether  the 
one  or  the  other,  we  should  have  to  secure  his  participation  in 
order  to  utilize  the  land  in  question  as  a  factor  in  production. 
And  what  necessarily  happened  to  early  societies,  shows  what 
will  always  prove  true:  we  can  never  get  rid  of  the  landlord 
as  an  agent  in  production.  All  we  can  do  will  be  to  substitute 
public,  for  private,  landlords. 

3.  The  third  agent  in  production  is  the  laborer,  meaning  any 
one  who  furnishes  services  which  are  the  product  of  his  own 
effort,    whether    these    services    are    high    or    low,    physical    or 
intellectual.    The  $100,000  president  of  a  corporation  is  a  laborer 
just  as  truly  as  his  office  boy. 

The  mark  which  distinguishes  the  laborer  from  any  other 
participant,  if  such  there  be,  who  furnishes  effort  services  is  the 
fact  that  services  such  as  his  can  be  hired.  Mr.  McGregor,  the 
South  University  grocer,  is  an  entrepreneur  because  he  is  re- 
sponsible for  the  business.  Further,  he  probably  does  as  much 
work  as  any  of  the  clerks.  But  most  of  his  efforts  pertain  to 
him,  not  as  entrepreneur,  but  as  laborer.  They  are  just  the 
sort  of  efforts  that  he  can  hire  other  men  to  put  forth,  and  that 
many  grocers  do  hire.  It  would,  therefore,  be  quite  illogical 


CHAPTER  II.  ANALYSIS  OF  PRODUCTION 

to  put  them  under  a  different  head.  Hence,  th«y  are  labor,  and 
with  respect  to  them  he  is  a  laborer. 

As  already  brought  out,  there  is  probably  a  residuum  of 
labor  which  must  be  performed  by  the  entrepreneur  as  entre- 
preneur. But  it  is  too  slight  in  amount  to  merit  serious  consid- 
eration. 

4.  The  fourth  agent  in  production  is  the  capitalist  proper. 
By  this  term  we  mean  the  one  who  lends  capital  to  be  used  in  a 
business,  but  does  not  assume  the  responsibility  of  the  business. 
The  return  of  his  capital  and  payment  for  its  use  (interest)  is 
assured  him.  The  special  function  of  the  capitalist  proper  is  to 
do  the  waiting  involved  in  industrial  processes,  just  as  the  spe- 
cial function  of  the  entrepreneur  is  to  assume  the  responsibility 
of  production.  The  bondholders  of  a  corporation  are  capital- 
ists ;  the  stockholders  are  elements  in  the  joint  entrepreneur. 

The  use  of  ''capitalist"  here  denned  is  somewhat  technical. 
Economists  often  employ  the  term  as  the  public  do,  i.e.,  to  include 
entrepreneurs  as  well  as  capitalists  proper.  From  some  stand- 
points, we  even  look  on  the  landlord  as  a  capitalist.  But  the 
ase  explained  above  is  frequent  and  at  times  convenient. 

Note:  It  is  scarcely  necessary  to  say  that,  in  the  real  world, 
there  is  never  probably  any  such  complete  separation  of  func- 
tions as  might  be  suggested  by  the  above  analysis.  The  same 
man  often  fills  two  or  more  roles.  The  typical  farmer  is  land- 
lord, capitalist,  laborer,  and  entrepreneur,  all  in  one.  The 
grocer,  in  the  above  illustration,  is  anyhow  entrepreneur,  capi- 
talist, and  laborer.  The  distinctions  made  are  primarily  func- 
tional; though  they  may  be,  to  a  considerable  extent,  personal 
as  well. 

ILLUSTRATIVE  PROBLEMS. 

1.  "In  cooperative  production    (meaning  production  in  which 
the  workmen  own  the  business)    the  place  of  the  entrepreneur 
is   taken   by  a   manager   elected   by  the    workmen." — Text-book. 
Criticize.     How   is   the    entrepreneur   constituted    in    cooperative 
production? 

2.  "Today,  all  over  the  land,  masons,  hod  carriers,  carpenters, 
and  so  on,  are  building  palaces  which  other  people  are  to  live  in. 
When  socialism  triumphs,  all  this  will  be  changed.    The  worker, 
no  longer  robbed  of  the  fruits  of  his  labor,  will  himself  occupy 
the  palaces  he  builds,  wear  the  broadcloth  he  makes,  and  eat  the 
choice  viands  he  produces." 

(a)  Does   justice   require  that   the   worker   should  have   the 
right  to  consume   the   particular  object  he  expends   effort  on? 
Explain. 

(b)  If  it  did,  would  the  particular  set  of  workers, — masons, 

45 


PRINCIPLES  OF  ECONOMICS 

hod  carriers,  carpenters,  and  so  on, — who  construct  the  palace, 
have  the  exclusive  right  to  enjoy  it?     Explain. 

(c)  Show  that  other  persons  besides  "workers"  in  the  sense 
here  used  have  supplied  conditions  necessary  to  the  existence  of 
the  palace. 

3.  Until    recently   it    was    usual    to    teach    that    the    peculiar 
function  of  the  entrepreneur  is  to  manage,  direct,  industry.    One 
feature  of  modern  industrial  organization  almost  compels  us  to 
reject  this  idea.     Explain. 

4.  "Postponing  consumption  so  that  production  may  be  car- 
ried on  in  a  roundabout  way  is  the  function  of  the  capitalist." 
— Text-book.    Explain  and  illustrate. 

5.  Why  do  we  say  that  every  stockholder  of  a  corporation  is 
an  element  in  the  corporate  entrepreneur  while  a  bondholder, 
who  also  has  capital  in  the  concern,  is  not? 

6.  Not  many  years  ago  Mr.  W,  after  some  months  of  pains- 
taking negotiation,    induced   a  number  of   persons   owning   cer- 
tain lands  on  the  Copper  Range  to  join  with  him  in  organizing 
a   corporation   to   build   a   railroad,    open    mines,    etc., — Mr.    W 
putting  in  some  land  of  his  own.     For  his  fee,  Mr.  W  was  to 
receive   a  certain   number  of  shares   in  the   stock  of  the  com- 
pany. 

Distinguish  with  explanations  the  two  economic  roles  played 
by  Mr.  W  in  this  matter. 

Section  C.    The  Costs  of  Production. 

A  very  important  phase  of  the  productive  process  is  cost, 
by  which  we  mean,  in  general,  some  sacrifice  which  has  to  be 
made  if  production  is  to  take  place. 

1.     Utility   Costs   and   Disutility   Costs. 

Costs  naturally  fall  into  two  classes,  (a)  utility  and  (b)  dis- 
utility costs.  By  utility  cost  we  mean  a  sacrifice  which  consists 
in  relinquishing  one  utility  to  gain  another.  I  have  intended  to 
use  certain  boards  to  make  a  cold  frame  for  roses.  I  decide  to 
use  them  making  a  walk.  I  have  intended  to  use  a  certain  sum 
of  money  to  put  a  new  porch  on  my  house.  Instead,  I  use  it 
to  take  a  trip  to  Muskoka  Lakes.  Here,  the  cold  frame  is  one 
of  the  costs  of  the  sidewalk;  the  porch,  the  cost  of  the  trip  to 
Muskoka. 

A  disutility  cost  means  a  sacrifice  which  consists  of  some 
action,  some  procedure,  which  m  itself  involves  discomfort; 
e.g.,  labor  when  one  is  weary.  Disutility  is  the  opposite  of 
utility. .  A  thing  possesses  utility  if  it  is  fitted  to  give  us  satis- 

46 


CHAPTER  II.  ANALYSIS  OF  PRODUCTION 

faction;  disutility  if  it  is  fitted  to  bring  us  dissatisfaction,  discom- 
fort. 

The  same  cost  may  be  either  a  disutility  cost  or  a  utility  cost, 
according  to  the  attitude  or  purpose  of  the  person  incurring  that 
cost.  Thus,  the  effort  which  I  expend  doing  an  errand  down 
town  is  a  disutility  cost  because  of  its  irksomeness;  but  it  may 
instead  be  viewed  as  a  utility  cost  because  I  might  have  ex- 
pended it  enlarging  my  rose  bed.  In  like  manner,  something 
naturally  viewed  as  a  utility  cost  may  really  be  a  disutility  cost 
in  disguise.  Thus,  if  I  give  up  the  cold  frame  entirely  in  order 
to  build  the  sidewalk,  the  cost  of  the  sidewalk  is  a  utility  cost. 
But,  if  all  the  time  I  intend  to  replace  the  lumber  from  later 
earnings  obtained  by  doing  work  which  I  would  not  otherwise 
have  done,  and  actually  carry  out  this  intention,  then  the  true 
cost  of  the  sidewalk  is  a  disutility  one,  the  effort  from  which  this 
portion  of  my  later  earnings  comes. 

Opportunity  cost  is  a  phrase  sometimes  used  to  cover  a  par- 
ticular kind  of  utility  cost.  If  a  workman's  reason  for  wanting 
a  wage  of  20  cents  an  hour  from  me  is  the  fact  that  he  can  «arn 
this  sum  from  some  one  else,  this  sum  expresses  the  opportunity 
cost  to  him  of  supplying  me  with  his  service.  When  a  land  owner 
can  rent  a  certain  piece  of  ground  for  pasture  at  $130  a  year 
and  I  want  it  for  a  golf  ground,  then  $130  is  the  opportunity 
cost  of  supplying  my  want. 

It  is  very  important  to  note  that  utility  and  disutility  costs, 
being  true  opposites,  are  entirely  commensurable.  That  is,  I  can 
properly  say  that  a  certain  utility  is  of  the  same  significance  to 
me  as  a  certain  disutility.  In  fact,  all  admit  that  we  make 
such  measurements  constantly  in  that  we  decide  that,  after  un- 
dergoing some  particular  disutility  cost  up  to  a  certain  point, 
the  reward  no  longer  pays  for  the  sacrifice. 

There  is  at  present  considerable  controversy  as  to  whether 
disutility  costs  really  play  any  considerable  part  in  the  existing 
economic  order,  especially  in  determining  value.  .  One  important 
group  of  recent  writers,  the  so-called  Austrian  school,  take  the 
negative  position ;  and  they  have  considerably  influenced  the 
opinion  of  others.  According  to  these  writers,  the  fact  that 
persons  to  whom  a  laborer's  services  are  worth  much  more 
than  20  cents  per  hour  have  to  pay  only  that  amount  is  due  to 
the  other  fact  that  such  labor  has  a  utility  or  opportunity  cost 
of  only  20  cents.  At  the  opposite  extreme  stand  some  who 

47 


PRINCIPLES  OF  ECONOMICS 

hold  that  the  price  of  such  labor  reaches  20  cents  because,  and 
only  because,  this  expresses  the  disutility  of  supplying  said  labor. 
In  the  present  course,  it  is  taught  that  both  utility  and  disutility 
costs  have  a  share  in  determining  value. 

2.     Kinds  of  Disutility  Cost. 

(a)  Disutility  Cost  of  Labor.     It   is  obvious  to  every  one 
that  labor  involves  one  or  more  disutilities,  and  that  these  con- 
stitute a  cost  of  production  in  some  sense,  if  not  a  true  eco- 
nomic  cost,  i.e.,  one  which   becomes   effective   in  the   economic 
realm.     The  most  conspicuous  of  these  disutilities  are   (1)   the 
irksomeness  of  the  labor  itelf  when  continued  beyond  a  certain 
point,  and  (2)  the  loss  of  leisure  which  might  give  opportunity 
for  positive  enjoyment. 

(b)  Disutility  Cost  of  Supplying  Capital.     Again  little  argu- 
ment is  needed  to  show  that,  speaking  generally,  the  supplying 
of  capital  involves  a  disutility,  and,  so,  is  in  some  sense  a  cost. 
The  man  who  furnishes  capital  doubtless  gets  back  a  full  equiv- 
alent; but,  then,  he  gets  it  back  at  a  later  period.     In  short,  he 
must  incur  the  sacrifice  or  disutility  of  waiting.     Now,  it  is  no 
doubt  true  that  this  waiting  is  not  a  cost  in  just  the  same  sense 
as  is  labor.    Further,  it  is  not  unlikely  that,  in  a  complete  theoretic- 
al analysis  of  the  matter,   some  more  precise  designation  than 
the  word  cost  could  be   found   for  this  particular   sacrifice   of 
waiting.     It  is  even  probable  that  they  are  right  who  say  that 
the  sacrifice  made  by  the  man  who  devotes  his  capacities  to  pro- 
ducing something  which  takes  time  as  well  as  labor  (something  for 
which  he  must  wait  as  well  as  work)   really  consists,  not  in  an 
addition  to  the  cost,  but  rather  in  a  deduction  from  the  return. 
But,  however  this  may  be,  there  is  no  doubt  that  we  have  here 
a  sacrifice  which  must  be  undergone  if  time-consuming  methods 
of  production  are  used  which  sacrifice  is  additional  to  the  sacri- 
fice  that   is    incurred    if   only   methods   not    requiring   time    are 
used.      That    sacrifice,    therefore,    is    an    additional    cost    in   the 
sense  in   which  the   term   was   defined   above   as   some   sacrifice 
which  has  to  be  made  if  production  is  to  take  place.    The  prod- 
uct requiring  time-consuming  methods  must  have  a  significance 
to  the   producer   greater    than   that   of   the   non-time-consuming 
one.     The  latter  must  have  a  capacity  to  give  him  satisfactions 
sufficient  to  offset  the   sacrifice  of   labor  which  it  involves,  but 
need   not  have   more.     The  time-consuming  product  must   have 

48 


CHAPTER  II.    ANALYSIS  OF  PRODUCTION. 

a  capacity  to  give  satisfactions  sufficient  to  offset  the  sacrifice 
of  the  labor  involved  and  also  that  of  the  waiting  involved. 
On  this  point  there  is  practically  no  disagreement.  This  being 
true,  the  controversy  becomes  chiefly  one  of  words.  As  the 
term  cost  is  naturally  understood  by  an  ordinarily  intelligent 
person,  waiting  is  a  cost  of  production.  To  find  any  other  term 
which  will  better  describe  its  relation  to  the  case  would  be  ex- 
tremely difficult,  if  not  quite  impossible. 

Another  objection  to  the  doctrine  that  waiting  or  abstinence 
is  a  cost  of  production  which  is  often  urged,  is  that  most  men 
who  accumulate  much  capital  have  such  large  incomes  that 
they  could  not  spend  those  incomes  if  they  tried  to.  To  them, 
therefore,  saving  involves  no  true  abstinence,  or  anyhow  no  dep- 
rivation. The  answer  is  this:  to  say  that  providing  any  par- 
ticular factor  of  production  involves,  in  general,  a  disutility  cost, 
is  not  to  say  that  this  is  true  in  every  single  case.  All  admit 
that  labor  involves  such  a  cost ;  but  some  labor  is  positively 
pleasurable.  So,  it  is  possible  that  some  men  are  in  such  a 
situation  that  spending  their  incomes  would  involve  more  dis- 
utility that  saving  them.  These  facts,  however,  do  not  justify 
us  in  denying  that  labor  and  capital,  taken  by  large,  involve  a 
disutility  cost.  To  be  more  specific,  all  such  questions  turn  on 
what  is  called  the  marginal  portion  of  the  supply,  that  is,  the 
portion  last  supplied,  or  the  portion  which  would  be  withheld  if 
any  were.  This  part  of  the  output  of  anything  is  the  significant 
one, — the  one  we  have  to  take  special  trouble  to  secure.  The 
men  who  supply  it  hold  the  key  to  the  situation.  They  must  be 
satisfied ;  and  to  them  labor  and  capital  have  disutility  costs. 
We  therefore  say  that  this  is  true  of  labor  and  capital,  gener- 
ally speaking. 

(c)  Disutility  Cost  of  Undertaking  the  Entrepreneur  Func- 
tion. We  have  seen  that  the  distinctive  function  of  the  entre- 
preneur is  to  assume  the  responsibility  of  production.  We  also 
noted  that  this  is  in  large  measure  a  function  which  must  be 
undertaken  by  capital  or  at  least  by  property; — the  entrepreneur 
can  not  normally  induce  the  outside  capitalist  to  supply  capital 
as  waiting  power  unless  he  (the  entrepreneur)  has  property 
which  can  be  pledged  to  insure  the  capitalist  proper  against  loss. 
Now,  in  thus  staking  his  property  "on  the  success  of  the  produc- 
tive process,  the  entrepreneur  surely  suffers  disutilities.  Not  to 
dwell  on  the  psychological  element  of  anxiety  and  general 

49 


PRINCIPLES  OF  ECONOMICS 

sense  of  burden,  he  manifestly  assumes  the  risk  of  losing  his 
pledged  property  in  whole  or  in  part.  For,  of  course,  there  is 
always  present  the  danger  that  there  will  take  place  unexpected 
changes  in  conditions  of  such  a  character  as  to  cause  him  to 
lose  more  or  less  of  his  property,  anyhow  of  the  value  of  that 
property.  In  so  far  as  such  losses  in  value  occur  with  consider- 
able regularity  in  the  life  of  a  business  so  that  they  can  be 
averaged  and  covered  by  an  addition  to  selling  price,  they  do 
not  constitute  a  new  kind  of  cost,  but  merely  an  addition  to 
the  amount  of  those  kinds  already  discussed.  The  persons 
engaged  in  the  productive  process  must  simply  undergo  more 
of  the  same  old  sacrifices,  labor  and  waiting.  But  there  are 
many  value-destroying  changes  which,  in  the  business  lifetime 
of  the  individual  entrepreneur,  show  no  such  regularity,  sub- 
mit to  no  average,  and  so  can  not  be  covered  by  an  addition  to 
price.  To  the  individual  entrepreneur  such  losses  are  final, 
never-to-be-recouped,  losses.  Assuming  the  risk  of  suffering 
such  losses  involves  to  most  persons  a  disutility  different  from, 
additional  to,  any  yet  considered.  Doubtless  some  people  of 
gambling  temperament  enjoy  assuming  such  risks,  and  so  would 
rather  take  them  than  not.  But,  in  my  opinion,  this  does  not 
represent  the  ordinary  entrepreneur  attitude  of  mind,  anyhow 
not  that  of  the  marginal  entrepreneur, — i.e.,  the  one  who  is 
least  disposed  to  stay  in  the  business,  who  would  be  the  first  to 
quit  were  conditions  made  more  onerous.  If  this  is  the  correct 
opinion,  then  responsibility-taking  must  be  viewed  as  one  of 
the  disutility  costs  of  production — one  of  the  sacrifices  which 
have  to  be  made  if  production  is  to  go  on. 

(d)  Disutility  Cost  of  Land.  Land,  as  understood  by  most 
economists,  is  the  indestructible  substratum  of  nature's  share  in 
production,  position  on  the  earth's  surface.  It,  therefore,  can  not 
be  produced  and,  so  has  no  primary,  original,  disutility  cost. 
But,  when  land  is  wanted  and  the  quantity  of  it  is  scarce  rela- 
tively to  wants,  it  of  course  will  come  to  have  value  like  any 
other  thing  which  is  wanted  and  scarce ;  and  when  land  thus 
comes  to  have  value,  the  owning  of  it  comes  to  involve  the 
burdens  (as  well  as  advantages)  which  belong  to  all  owning  of 
wealth.  That  is  (1)  the  owner  must  forego  the  enjoyment  of 
some  immediate,  present,  form  of  wealth  which  he  could  get 
with  the  money  tied  up  in  the  land  (to  use  the  business  man's 
language)  ;  and  (2)  he  must  run  the  risk  of  having  the  value 

50 


CHAPTER  II.    ANALYSIS  OF  PRODUCTION. 

of  the  land  decline.  In  short,  owning  the  land  involves  the  two 
disutilities  which,  as  already  shown,  attach  to  capital,  viz.,  wait- 
ing and  risk-taking;  though,  in  the  case  of  land,  these  disutili- 
ties present  themselves  as  derivative,  not  original,  disutilities. 
But,  while  supplying  the  land  factor  in  production  comes  to  in- 
volve disutility  costs,  these  are  not  new  ones  but  those  already 
brought  out  as  attaching  to  capital.  Hence,  summarizing  this 
whole  account  of  disutility  costs,  we  may  say  the  chief  costs 
of  this  sort  are  three:  (1)  labor,  (2)  waiting,  and  (3)  risk- 
taking. 

3.  Utility   Costs. 

We  have  already  seen  that  a  thing  has  a  utility  cost  pro- 
vided the  production  of  that  thing  involves  sacrificing  some 
other  thing  which  would  have  supplied  one  or  more  utilities. 
It  is  evident  that  supplying  any  one  of  the  three  factors,  land, 
labor,  and  capital,  may  involve  such  a  utility  cost;  for  any  one 
of  them  may  be  put  to  different  uses,  and  any  one  of  these 
uses  may  be  conceived  as  a  cost  in  producing  one  of  the  others. 

4.  Money  Costs. 

The  disutility  and  utility  costs  just  considered  are  to  be  con- 
ceived as  sacrifices  made  by  the  persons  actitally  participating 
in  production.  They  are  often  spoken  of  as  the  real  costs 
of  production  or  simply  costs.  In  contrast  we  have  the  money 
costs  (often  called  expenses),  the  outlay  in  money  which  en- 
trepreneurs have  to  make  in  order  to  get  the  various  elements 
which  they  need  in  their  productive  operations.  This  statement, 
however,  must  be  interpreted  so  as  to  make  money  costs  include 
any  sum  which  the  entrepreneur  allows  himself  for  factors  or 
services  which  he  might  have  bought  but  which,  in  fact,  he 
himself  supplies.  Thus,  if  the  entrepreneur  himself  works  as 
manager  or  bookkeeper  or  clerk,  he  allows  himself  wages,  and 
we  should  count  these  as  part  of  the  money  cost.  So,  if  he  has 
capital  invested  in  the  business — surely  he  almost  always  has, — 
he  allows  himself  interest  on  this  capital,  and  that  interest  we 
include  in  the  money  costs.  True  profits,  the  return  going  to 
the  entrepreneur  as  such,  i.e.,  to  the  entrepreneur  ignoring  his 
contributions  as  a  laborer  or  a  capitalist, — these  are  the  reward 
of  a  service  which  could  not  from  its  very  nature  be  bought 
on  the  market;  this  element  would  not,  therefore,  be  counted 
as  part  of  money  costs.  However,  it  will  be  included  in  entre- 

51 


PRINCIPLES  OF  ECONOMICS 

preneur's  costs,  which  will  be  explained  in  a  moment;  and,  in 
this  course,  it  will  usually  be  included  when  the  word  cost  is 
used  without  any  qualifying  term. 

It  would  probably  be  granted  by  every  one  that  money  costs 
in  some  sense  and  degree  represent  the  real  costs  of  production, 
though  opinions  would  differ  as  to  the  exactness  of  such  repre- 
sentation. Those  who  believe  that  utility,  opportunity,  costs 
play  the  decisive  part  in  fixing  rent,  wages,  and  interest,  natur- 
ally look  on  money  costs  as  quite  closely  corresponding  to  utility 
costs.  Those  who  believe  that  disutility  costs  have  much  to  do 
in  determining  wages  and  interest,  look  on  money  costs  as  a 
fairly  precise  expression  of  disutility  costs.  Money  costs  are, 
in  any  case,  of  much  greater  significance  in  economic  science 
than  real  costs  of  either  sort,  since  they  are  the  only  available 
expression  of  such  costs.  Granting  that  a  knowledge  of  the 
sacrifice  made  by  laborers  or  capitalists  is  important  to  us,  it 
is  plain  that  we  can  get  such  knowledge  only  by  assuming  that 
the  extent  of  the  sacrifice  is  expressed  in  the  money  prices 
which  we  have  to  pay  to  get  men  to  undergo  such  sacrifice. 

In  enumerating  the  money  costs,  it  would  perhaps  seem  nat- 
ural to  group  them  just  as  we  group  the  real  costs  which  they 
more  or  less  fully  express;  and  this  could  be  done  in  a  rough 
way.  That  is,  we  could  reduce  substantially  all  money  costs 
to  the  money  value  of  labor,  of  waiting,  and  of  risk-taking,  or 
in  other  words  to  wages,  interest,  and  profits.  But  a  good  deal 
of  the  labor,  waiting,  and-  risk-taking  which  enter  into  the  cost 
of  a"  particular  commodity,  come  over  from  the  past  in  the  shape 
of  goods  which  were  earlier  produced  and  are  now  being  used 
in  the  current  process.  The  price  which  the  entrepreneur  has 
had  to  pay  for  these  goods  has  often  departed  more  or  less 
from  that  price  which  expressed  their  real  cost,  and  so  we  can 
not  use  the  latter  as  an  equivalent  of  their  cost  in  the  current 
productive  process.  It  is  therefore  best,  in  reckoning  money 
cost,  to  set  down  the  actual  market  value  of  past  products  used, 
without  attempting  to  analyze  them  into  their  ultimate  money 
costs — wages,  interest,  and  profits.  We  have,  then,  as  the  appar- 
ent money  costs  of  production  the  following: 

(1)  Rent  of  the  site. 

(2)  Hire  (rent  in  popular  usage)  of  buildings  or  other  dur- 
able capital  goods. 

(3)  Money  value   of   capital  goods   consumed,   such  as   raw 
materials,  tools,  machines,  etc. 

52 


CHAPTER   II.    ANALYSIS    OF    PRODUCTION 

(4)  Wages    of   current  labor, — covering  labor    of   all   kinds, 
including  both  wages  in  the  ordinary  sense  and  salaries. 

(5)  Interest  on  all  the  money  capital  currently  invested  in 
the  business  where  such  interest  is  not  already  covered  under 
preceding  heads. 

Comments:  (a)  The  case  of  rent  as  a  money  cost  presents 
considerable  difficulties.  The  more  othodox  doctrine  makes  it 
sometimes  a  cost,  sometimes  not.  As  already  brought  out,  in 
so  far  as  it  represents  disutility  costs  at  all,  these  are  not  orig- 
inal but  derivative.  Being  such,  they  are  important  in  some 
cases,  e.g.,  questions  of  justice  in  distribution;  unimportant  in 
others,  e.g.,  in  questions  of  value  or  price  determination.  But 
rent  .sometimes  represents  a  utility  or  opportunity  cost.  In  that 
case,  it  is  important  in  problems  of  value  or  price  but  not  in 
problems  of  distributive  justice.  But  these  nicer  matters  of 
theory  will  necessarily  come  up  again  in  other  connections. 
Generally  speaking,  all  are  agreed  that  rent  is  a  money  cost  to 
this  extent  that  the  individual  entrepreneur  is  usually  con- 
strained to  treat  it  as  one  of  the  outlays  which  are  prerequisites 
of  the  productive  process. 

(b)  Costs  (2),  (3),  and  (4)  need  no  comment.  Number 
(5)  is  not  quite  so  simple.  It  includes,  first,  interest  paid  out 
by  the  entrepreneur  to  others  from  whom  any  part  of  his  capi- 
is  borrowed,  and,  secondly,  interest  credited  to  himself  on  any 
capital  which  he  has  himself  put  into  the  business.  The  first 
is  a  plain  case.  The  second  perhaps  deserves  a  word.  Suppose 
the  entrepreneur  buys  with  his  own  money,  say,  $40,000  worth 
of  lumber  to  be  worked  up  into  furniture.  Evidently  the  re- 
sulting furniture  costs  this  $40,000  anyhow — this  item  being 
covered  under  cost  No.  (3)  ; — but,  in  addition,  it  costs  interest 
on  the  $40,000  for  the  period  ordinarily  required  from  the  time 
the  lumber  is  bought  till  the  furniture  is  sold  and  paid  for. 
Supposing  this  period  to  be  one  year,  then  with  interest  at  5^2 
per  cent,  we  have  here  a  cost  of  $2,200,  which  must  be  charged 
to  the  furniture  and  credited  to  the  entrepreneur.  In  a  similar 
way,  if  he  uses  $20,000  worth  of  machinery,  the  cost  of  keeping 
it  up, — repairs  and  replacement — will  be  provided  for  under 
cost  No.  (3)  ;  but  interest  on  $20,000,  i.e.,  $1,100,  must  also  be 
earned,  and  this  must  be  charged  to  the  furniture  and  credited 
to  the  entrepreneur.  Similarly,  if  he  finds  it  necessary  for  the 
efficient  running  of  this  business  to  keep  a  balance  with  his 
bank  of,  say,  $800,  interest  on  this,  $44,  must  be  charged  to  the 
furniture  and  credited  to  the  entrepreneur.* 

5.    The  Entrepreneur's  Cost. 

The  particular  kind  of  cost  having  greatest  practical  signifi- 
cance in  economic  discussions  is  cost  to  the  entrepreneur,  the 

*Remember  that  we  are  here  talking  about  capital  which  he  himself  puts 
in.  If  any  of  these  items  are  covered  from  borrowed  capital,  their  interest 
is  provided  .for  in  the  first  part  of  this  paragraph. 

53 


PRINCIPLES  OF  ECONOMICS 

responsible  producer;  for  his  sacrifice  plays  a  large  part  in 
determining  the  prices  of  goods.  Cost  to  him  might  very  natur- 
ally be  looked  on  as  breaking  into  two  parts:  (a)  Money  out- 
lay, (b)  All  sacrifices  undergone  by  himself,  e.g.,  in  supplying 
the  capital  which  he  himself  furnishes,  in  performing  different 
kinds  of  labor,  in  taking  the  responsibility  of  having  production 
go  on.  In  practice,  however,  the  entrepreneur  usually  divides 
cost  in  the  way  already  hinted  at.  That  is,  such  parts  of  his 
own  contribution  as  could  be  bought  on  the  market  and.  so, 
have  known  prices,  he  reckons  in  terms  of  money,  just  as  if 
he  had  purchased  them  from  other  people.  This  leaves  only 
one  cost  unprovided  for,  i.e.,  the  sacrifice  or  disutility  of  assum- 
ing the  responsibility  of  production  which  necessarily  forms  a 
class  by  itself.  According  to  this  analysis,  Entrepreneur's  Costs 
classify  as  follows: 

(a)  Money  Costs. 

(1)  Actual  outlay  of  the  Entrepreneur. 

(2)  Expression  in  money  of  the   Entrepreneur's  contributions, 
in  so  far  as  they  are  purchasable. 

(b)  Real  cost  or  sacrifice  of  assuming  ultimate  responsibil- 
ity,— this    having    its    objective    expression    in    money    profits. 

It  is  Entrepreneur's  Cost  which  we  shall  usually  have  in 
mind  when  employing  the  term  cost  without  a  qualifying  term. 
That  is,  we  shall  commonly  mean  by  cost  money  cost,  as  already 
defined,  plus  such  amount  of  profits  as  is  necessary  to  insure 
the  entrepreneur's  continuance  in  the  business. 

ILLUSTRATIVE  PROBLEMS. 

1.  Suppose  that  a  Crusoe  has  some  article,  say  an  umbrella, 
which  he  considers  quite  indispensable,  and  that  he  is  reflecting 
on  what  it  would  cost  him  to  replace  it,  if  it  were  destroyed. 

(a)  Make  a  hypothesis  under  which  that  cost  would  present 
itself  as  a  utility  cost. 

(b)  Make  a  different  hypothesis  changing  the  cost  to  a  dis- 
utility one. 

2.  Suppose  that   Crusoe  looked   on  his  umbrella   as  having 
a  utility  to  him  which  he  estimated  at  $10.     Suppose,  further, 
that  he  could  make  another  just  as  good  with  five  days'  labor 
and  that  he  estimated  the  disutility  of  a  day's  labor  at  $1. 

(a)  What  is  meant  by  the  last  clause? 

(b)  Is   it   reasonable  to   estimate   the   disutility   of   a   day's 
labor  in  such  a  way? 

(c)  What  value  would  Crusoe  probably  set  on  the  umbrella? 
why? 

(d)  What  would  determine  that  value— utility  or  cost? 

54 


CHAPTER  II.    ANALYSIS  OF  PRODUCTION. 

3.  Here  is  a  site  which  yields  each  year  a  net  income   of 
$1,000,  and  which  will  presumably  keep  on  doing  ihis  indefinite- 
ly.    Seemingly  such  a  site  ought  to  be  worth  $1,000  multiplied 
by  infinity,  or,  as  human  beings  can  not  be  expected  to  reckon 
so   far  ahead,  let  us  say  by  100;  that  is,  it  ought  to  be  iworth 
$100,000.     As   a   matter   of   fact,   the  site   would   not  be  worth 
more  than  $20,000.     How  do  you  explain  the  discrepancy? 

4.  We  often   hear   people   complain   of   what  they  consider 
the  unreasonable  profits  of  druggists  or  other  merchants,  say- 
ing that  these  dealers  clear  from  fifty  to  one  hundred  per  cent 
on  a  large  part  of  their  sales,  while  they  have  no  right  to  more 
than  eight  or  ten  per  cent.     Does  the  fact  that  fifty  or  a  hun- 
dred per  cent  are  cleared  on  individual  sales  prove  that  a  mer- 
chant gets  more  than  eight  or  ten  per  cent  real  profit? 

5.  Suppose  that  democratic  socialism  has  replaced  the  pres- 
ent order  so  that  the  state,  governed  as  a  democracy,  is  the  sole 
landlord,  capitalist,  and  entrepreneur,  hiring  its  citizens  to  labor 
at  the  various  kinds  of  work  needed,  paying  them  wages,  and 
selling  them  the  various  kinds  of  goods  produced. 

(a)  Show  that  it  would  be  desirable  from  time  to  time  to 
increase  the  amount  of  capital  at  the  disposal  of  the  state. 

(b)  Show  that  this  increasing  of  the  capital  would  require 
abstinence  -on  the   part  of  the  citizens.      (Under   a   democratic 
socialism,  effort  would  doubtless  be  made  to  distribute  this  bur- 
den equally  for  the  time  being.) 

(c)  Show  that,  in  the  long  run,  equity,  as  commonly  under- 
stood, would  require  that  the  state  should  charge  a  higher  price 
for  a  product  costing  a  certain  amount  of  labor  plus  five  years 
of  waiting,  than  for  another  product  costing  an  equal  amount 
of  labor  and  only  one  year  of  waiting. 

(d)  What  money  cost  in  our  system  would  this  difference 
in  price  represent? 

6.  The   stockholders   of   a  bank  put   into  the  business   only 
$100,000:  yet  the  bank  takes  in  five  or  six  per  cent  interest  on 
loans   which   amount   to,   perhaps,   $900,000.      Must  we   not   say 
that   such   a   bank   is   making  outrageously   large  profits?     No. 
Explain. 

Section  D.    What  is  it  to  Produce? 

Up  to  this  point  we  have  assumed  that  the  general  nature 
of  production  is  so  well  understood  that  no  discussion  or  ex- 
planation of  this  point  is  needed.  This  procedure  was  perhaps 
justified  in  that  (1)  up  to  this  point  we  have  had  little  if  any 
need  for  a  clearly  defined  conception  of  production,  and  (2) 
such  a  conception  could  not  be  worked  out  at  all  easily  before 
the  analysis  which  we  have  given  had  been  mastered.  Now, 
however,  we  must  go  into  this  matter  somewhat  fully. 

55 


PRINCIPLES  OF  ECONOMICS 

1.     The  Word  Production  will  be  used  in  Different  Senses. 

It  is  no  doubt  theoretically  desirable  to  employ  every  scien- 
tific term  in  just  one  sense.  But,  in  fact,  such  precision  is  rare- 
ly possible  and  under  actual  conditions  seldom  expedient.  Such 
a  course  would  require  us  to  neglect  important  points  of  view 
or  spend  much  of  our  time  coining  new  terms.  Production  is 
a  word  which  most  of  us,  probably,  use  in  several  different 
senses,  some  broader,  some  narrower.  This  will  doubtless  con- 
tinue to  be  the  case;  and  little  harm  need  result,  if  we  are 
careful  to  preserve  consistency  in  the  matter.  The  gravest 
danger  is  that  we  shall  affirm  or  deny  that  some  one  produces 
in  one  particular  sense,  and  then  in  a  moment  deduce  prac- 
tical consequences  from  our  affirmation  as  if  it  had  been  made 
in  a  quite  different  sense.  Thus,  there  is  a  proper  enough 
meaning  of  the  word  producer  which  permits  its  application  to 
the  market-gardener  but  not  to  the  grocer.  But,  if  we  say 
"the  grocer  is  not  a  producer  (in  this  sense)  therefore  he  is 
a  parasite"  we  are  confusing  two  quite  different  meanings.  In 
the  sense  that  a  producer  is  one  who  extracts  or  grows  or 
makes  some  particular  thing,  the  grocer  is  not  a  producer.  In 
the  sense  that  a  producer  is  one  who  does  something  which 
contributes  to  the  satisfying  of  our  wants,  the  grocer  is  a  pro- 
ducer; and  so,  of  course,  he  is  not  a  parasite,  since  a  parasite 
is  a  person  who  takes  without  giving  anything  in  return. 

2.     Broad    Meaning    of    Produce. 

The  meaning  of  produce  which  will  be  most  used  in  this 
course  and  which  probably  has  most  vogue  among  present-day 
economists,  -may  be  brought  out  by  the  following  statement :  To 
make  any  contribution  to  the  satisfying  of  human  wants, 
whether  this  is  done  by  persons  or  things,  provided  said  con- 
tribution has  a  price  or  value,  is  to  produce.  The  idea  of  this 
definition  is  to  recognize  as  productive  anything  which  is  re- 
sponsible, in  any  sense  or  degree,  for  the  existence  of  the  prod- 
uct, provided  it  has  an  economic  character.  That  such  a  way 
of  conceiving  production  is  reasonable  ought  not  to  be  difficult 
to  show.  That,  in  general,  we  naturally  go  as  far  as  possible 
in  admitting  whatever  is  responsible  for  the  product,  seems  al- 
most self-evident.  Surely  the  fundamental  reason  for  calling 
any  act  or  thing  productive  is  the  fact  that  the  existence  of  the 
product  is  conditioned  upon  it;  and  it  would  not  appear  on  the 

56 


CHAPTER    II.    ANALYSIS    OF    PRODUCTION 

face  of  things  reasonable  to  shut  out  the  supplying  of  one  con- 
dition while  admitting  another, — to  call  the  raising  of  straw- 
berries productive,  the  carrying  of  them  to  market  unproduc- 
tive, or  to  call  the  making  of  a  lawn  mower  productive,  using 
it  to  mow  a  lawn  unproductive.  Our  real  difficulty,  then,  is  to 
justify  our  definition  in  respect,  not  to  its  breadth,  but  rather 
to  its  narrowness.  Can  we  reasonably  put  in  the  qualification : 
"provided  said  contribution  has  a  price?" 

In  the  light  of  previous  discussions,  an  affirmative  answer 
is  inevitable.  We  are  studying  economics,  not  physical  science. 
The  sort  of  production  we  are  concerned  with  is  economic,  not 
physical,  production.  But  economics,  as  such,  takes  account  only 
of  those  things  which  are  economic, — i.e.,  which  have  to  be 
treated  economically,  have  value  or  price.  Our  definition  of 
production,  therefore,  has  to  be  restricted  to  acts  or  conditions 
which  have  a  price. 

Comments:  (a)  The  emphasis  laid  on  price  in  the  above 
definition  must  not  lead  the  student  to  imagine  that  said  defini- 
tion would  be  quite  unsuited  for  an  economic  order  radically 
different  from  the  present  one,  e.g.,  communism.  In  such  an 
order,  value  would  still  be  used  to  express  the  relative  import- 
ance of  things;  and  the  communal  bookkeeping  would  credit 
something  of  the  product  to  such  factors'  a's  possessed  an  eco- 
nomic character — had  value — but  not  to  the  others. 

(b)  The  emphasis  laid  on  price  or  value  must  not  lead  us 
to  imagine  that  to  produce  is  to  be  responsible  for  the  existence 
of  value.  It  is,  of  course,  the  production  of  wealth  that  we  are 
talking  about;  and,  since  wealth  has  value,  it  might  seem  that 
to  produce  one  must  create  value.  But  this  is  a  mistake.  The 
producer  as  such  is  not  responsible  for  every  element  in  wealth, 
but  only  for  its  fitness  to  satisfy  wants, — its  utility.  His  task 
is  to  do  whatever  needs  to  be  done  in  order  to  give  wealth  this 
fitness — this  utility.  Many  obstacles  stand  in  the  way  of  having 
things  just  right  to  satisfy  wants.  Many  conditions  must  be 
fulfilled  before  the  result  is  reached.  To  overcome  any  of  those 
obstacles,  to  fulfill  any  of  these  conditions,  is  to  produce.  Now, 
these  conditions  must  be  fulfilled  before  people  will  want  things 
and,  so,  before  things  will  have  value.  The  producer,  therefore, 
is  contributing  toward  the  existence  of  value.  But  something 
more  is  necessary  which  the  producer  does  not  supply,  viz.,  a 
demand  on  the  part  of  others.  Still  another  thing  is  necessary 
which  he  is  really  neutralizing,  viz.,  scarcity.  Accordingly,  it  is 
not  proper  to  describe  production  as  "the  creating  of  value." 
We  can  conceive  acts  which  would  tend  to  increase  value  which 
are  the  very  opposite  of  productive,  e.g.,  destroying  a  portion 
of  a  tobacco  or  coffee  crop. 

57 


PRINCIPLES  OF  ECONOMICS 

(c)  We  have  laid  so  much  stress  on  utility,  as  the  element 
which    the    producer   is    responsible    for  that   some    further   ex- 
planation of  the  term  seems  needful.     In  general  the  economist 
means  by  utility  capacity   to  satisfy  wants.     More  particularly, 
he  applies  the  term  to  any  such  capacity,  whatever  be  the  par- 
ticular want  involved.     Thus,  the  capacity  to  give  one  aesthetic 
enjoyment  or  even  vicious   enjoyment  is  utility.     To  the   econ- 
omist,  diamonds   and  whisky  are  just  as   truly  useful  as  coal 
or  bread.* 

Still  further  denning  the  economist's  use  of  this  term,  it 
should  be  said  that  utility  includes  not  merely  those  conditions 
which  inhere,  so  to  speak,  in  the  object  itself,  but  also  those 
conditions  which  consist  in  the  relations  of  said  vbject  to  men. 
Thus  a  loaf  of  bread  situated  in  a  place  where  it  is  wanted  is 
more  useful  than  un  exactly  similar  one  situated  where  it  is  not 
wanted. 

Accordingly,  the  economist  recognizes  several  kinds  of  utility 
which  at  first  have  a  strange  sound.  Thus,  he  talks  of  place 
utility,  illustrated  when  the  bread  is  carried  from  the  place 
where  it  is  not  wanted  to  the  place  where  it  is  wanted;  time 
utility,  illustrated  when  ice  is  kept  from  the  cold  months  when 
it  is  not  wanted  till  the  warm  ones  when  it  is  wanted ;  and 
ownership  utility,  illustrated  when  a  commodity  passes  from 
the  hands  of  one  who  has  no  need  for  it  to  those  of  one  who 
has  such  need.  More  obvious  forms  of  utility  are  elementary 
or  substance  utility,  illustrated  where  copper  is  gotten  out  of 
the  mines  of  the  Lake  Superior  region  ready  to  be  used  in  the 
making  of  wire;  and  form  utility,  illustrated  when  that  copper 
is  made  into  wire  ready  to  be  used  in  carrying  an  electric  cur- 
rent. 

(d)  It  is  hardly  necessary  to  say  that  those  who  favor  the 
broad   definition  of  production   which  we  are  now   considering, 
include  among  producers  not  only  those  who  supply  commod- 
ities, i.e.,  material  objects  having  value,  but  also  those  who  sup- 
ply personal  services,  i.e.,  desirable  changes  in  the  conditions 
of    objects    or   persons    effected    by    other   persons    and   having 
value.t     See  Reading  IV. 

(e)  It  is  hardly  necessary  to  say  that  acts  which  are  pro- 
ductive   under    one    set    of    conditions    may    not   be    productive 
under  another  set  of  conditions,  in  that  they  contribute  to  the 


*This  of  course  does  not  mean  that  the  economist  holds  different  ideas 
from  other  people  as  to  the  relative  importance  of  necessaries  and  luxuries 
or  as  to  the  undesirableness  of  whiskey-drinking.  But,  from  our  standpoint, 
it  is  necessary  to  recognize  the  common  element  in  diamonds,  whiskey, 
and  bread,  i.e..  the  capacity  to  satisfy  human  wants;  and  utility  seems  to 
be  the  only  suitable  word  for  the  purpose. 

•{•  Commodities  and  services  are  contrasted  most  sharply  in  that  the 
former  can  be  delivered  to  the  person  who  buys  them  after  they  have 
been  made, — independently  of  the  producing  process;  while  services  can 
be  delivered  to,  appropriated  by,  the  person  who  is  buying  them,  only 
while  they  are  being  produced.  Services  are  usually  changes  in  the  condi- 
tion of  the  property  or  person  of  the  one  who  buys  them.  In  consequence, 
they  must  usually  be  produced  in  connection  with  such  property  or  person. 

58 


CHAPTER   II.    ANALYSIS    OF    PRODUCTION 

satisfaction  of  wants  under  the  first  set  but  not  under  the  sec- 
ond. In  particular,  some  acts  which  are  useful  under  the  pres- 
ent economic  order  might  not  be  under  socialism.  Persons 
performing  such  acts  would  therefore  be  producers  in  the  first 
case  but  not  in  the  second. 

(f)  It  does  not  follow  from  pur  account  of  the  nature  of 
production  that  every  one  whom  it  accounts  a  producer  really 
deserves  the   share  which  he  gets  for  his  contribution.     Thus, 
it  may  be  that  the  legal  arrangements  under  which  he  is  per- 
mitted to  control  a  certain  factor  of  production,  say  land,  and 
so  to  make  a  certain  contribution  to  production,  are  quite  wrong. 
But,    so    long   as   those   arrangements    prevail,   the    contribution 
has  to  be  imputed  to  him,  and  so  he  is  a  producer.     The  con- 
troversy, however,  really  belongs  to  a  later  division  of  the  sub- 
ject, i.e.,  Distribution. 

(g)  If   we    wish   to    express    ourselves    with   precision,    we 
should  attribute  to  each  producer  the  particular  commodity  or 
service    for    which    he    is    immediately   responsible.     Thus,    the 
farmer  produces,  not  bread  or  flour,  but  wheat.    The  miller  pro- 
duces not  bread,  but  flour.     The  employees  of  the  miller  pro- 
duce  not   flour,    but    services,   which   the  miller   combines   with 
the  services  of  various  machines  and  wheat  in  such  a  way  that 
he  produces  flour. 

ILLUSTRATIVE  PROBLEMS. 

1.  Is  it  fair  to  say  that  the  conception  of  produce  held  by 
a   man   who   calls   all   non-producers   parasites   is   the    same   as 
the  one  we  have  been  considering? 

2.  "St.  Thomas  is  not  a  producing  island.     Its  importance 
consists  in  its  position  as  a  harbor  of  refuge  and  a  coaling  sta- 
tion, and  as  a  place  for  refitting  vessels."    Show  from  the  pas- 
sage that  St.  Thomas  is  a  producing  island,  as  we  understand 
the  word. 

3.  Have  the  playing  cards  of  a  gambler  utility?     Are  they 
wealth?    Has  a  diamond  ring  utility? 

4.  A   man   who   is   getting   no  income   now   but   expects   to 
have  one  six  months  from  now  borrows  $100  from  his  neighor, 
promising  to  pay  back  the  $100  and  $6  more  at  the  end  of  a 
year. 

(a)  Does    the    $6    represent    any    advantage, — service, — re- 
ceived by  the  borrower? 

(b)  If  so,  can  the  lender  reasonably  be  credited  with  the 
production  of  that  service? 

5.  "Only  miners,  lumbermen,  farmers,  and  such  like  ought 
to   be  called  producers;    for  they  are   the  only  ones  who  add 
something  to   the   total    wealth.      The    rest   merely   change   the 
form   or  relations   of   the  things  which  the   above-named  pro- 
duce." 

Show  that  there   is  no  essential   difference  in  the  contribu- 

59 


PRINCIPLES  OF  ECONOMICS 

tions  of  the  farmer,  the  miller,  the  baker,  the  grocer,  and  the 
delivery  man. 

6.  "The    Chinaman    lives    economically.      He    earns    all    he 
possibly  can  and  saves  it  and  takes  it  back  to  his  native  land. 
He  is  a  very  economical  consumer,   and  instead    of    being    a 
wealth  producer,  acts  as  a  leech  upon  the  wealth  of  the  nation, 
sucking  in  all  that  he  can  and  taking  it  away  to  enrich  the  land 
of  his  ancestors."    Criticise  the  part  in  italics. 

7.  "Only  the   people   who  work  with  their  hands  are  true 
producers.     All  the  rest  live  off  them." 

Argue  that  brainworkers,  managers,  architects,  inventors,  et 
al.  are  also  producers. 

8.  "A  service  is  not  a  material  thing  but  a  satisfaction  pro- 
duced in  us  by  means  of  the  goods  or  efforts  of  other  persons." 
Criticize. 

9.  Mr.  X.  hires  the  opera  house  for  an  evening  and  hires 
the   Mendelssohn  Quartette  to  give  a  concert  in  it.     I  pay  75 
cents  to  hear  the  concert. 

(a)  In  precisely  what  does  the  wealth  which  I  buy  consist, 
the  work  of  the  singers,  the  pleasure  I  derive  from  the  singing, 
or  something  else? 

(b)  Did   the    Quartette   produce   the   wealth    I    bought,    or 
something  else? 

(c)  If  the  Quartette  did  not,  who  did? 

10.  "Thus  there  are  today  tens  of  thousand  of  lawyers,  bank- 
ers, traders,  middlemen,  speculators,  and  others,  whose  functions, 
necessary  to   the   capitalistic   regime,  would    (under   socialism) 
cease  to  have  any  value.     They  would  be  compelled  because  of 
this  to  enter  the  producing  class." 

(a)  Show  from  the  quotation  itself  that,  under  a  reason- 
able interpretation  of  the  phrase  "  producing  class,"  the  groups 
of  persons  named  are  already  in  that  class. 

(b)  May  the  labors   of   these  persons   be  productive   now, 
although  they  would  not  be  productive  under  socialism.    Don't 
forget  to  explain. 

11.  "Labor   alone    is    the    producer    of    wealth;    take    away 
labor  and  not  all  the  capital  in  the  world  could  produce   any- 
thing." 

Allowing  the  second  clause  to  be  true  as  a  statement  of  fact, 
does  it  prove  the  proposition  contained  in  the  first? 

12.  Accepting  the  conception  of  wealth  given  in  these  Out- 
lines,  the  conductor  of   a   street  car  is   a  producer  of   wealth. 

(a)  Just  what  form  of  wealth  does  he  produce? 

(b)  For  whom  does  he  produce  it? 

(c)  Who  produces   the  wealth    I  buy  when  I   ride  in  the 
cars? 

IS'.     If  we  wished  to  be  very  precise,  could  we  say  that  the 
miner  of  silver  produces  silver"? 

60 


CHAPTER    II.    ANALYSIS    OF    PRODUCTION 

3.     Narrow  Meaning  of   Production. 

For  most  purposes,  most  economists  nowadays  use  produc- 
tion in  the  broad  sense  already  elaborated.  In  some  connec- 
tions, however,  we  find  it  convenient  to  follow  the  popular 
usage  which  cuts  off  one  class  of  producers  from  the  rest, 
representing  them  as  mediators  between  producers  and  con- 
sumers. I  have  in  mind,  of  course,  the  exchanging  class,  who 
occupy  a  unique  place  in  the  system  in  that  they  appear  at 
every  stage  in  the  long  chain  of  processes  leading  from  the 
first-stage  producers  to  the  ultimate  consumer,  mediating  be- 
tween each  member  of  the  technical  part  of  the  series  and  his 
next  neighbor.  Thus  they  act  as  go-betweens  between  the 
stock-raisers  and  the  tanners;  between  the  tanners  and  the 
shoemakers ;  between  the  shoemakers  and  the  shoe-wearers.  Ac- 
cordingly, we  often  find  it  convenient  to  use  expressions  like 
this :  "It  is  the  function  of  the  exchanging  class  to  correlate 
producers  and  consumers."  That  is,  we  sometimes  use  the 
term  producers  to  include  all  sorts  of  contributors  to  the  pro- 
duction of  commodities  and  services  except  the  exchanging 
class.  No  harm  need  result  from  this,  if  we  remember  that 
in  the  deeper,  larger  sense,  all  who  contribute  in  any  kind  or 
degree  to  the  existence  of  utilities  are  producers. 

4.  Special  Antithesis  of  Productive  and  Consumptive. 
There  is  one  narrow  use  of  the  adjective  "productive,"  though 
the  verb  ''produce"  has  no  corresponding  use,  which  still  has  con- 
siderable vogue  among  economists.  It  is  often  criticised  as  in- 
consistent with  the  broad  use  of  "produce"  above  explained, 
though,  as  it  seems  to  me,  without  good  reason.  This  use  is 
illustrated  when  we  say:  "The  communist  wants  to  have  all 
wealth,  including  consumptive  goods,  owned  by  the  state,  while 
the  socialist  would  limit  state  ownership  to  productive  goods, 
such  as  land  used  for  productive  purposes,  machines,  raw  mate- 
rial, etc."  In  like  manner,  we  call  the  services  of  the  men 
whom  Mr.  Knickerbocker  hires  to  work  his  mill  productive, 
while  the  services  of  his  coachman  are  unproductive  or  con- 
sumptive. It  may  be  that,  in  the  interest  of  clearness,  we  had 
better  adopt  a  different  phraseology;  but  I  see  no  inconsistency 
between  this  antithesis  of  productive  and  consumptive  and  our 
definition  of  produce.  This  antithesis  is  concerned,  not  with 
the  productive  act,  but  with  the  destination  of  the  product  of 

61 


PRINCIPLES  OF  ECONOMICS 

that  act.  Of  course,  the  coachman  produces  just  as  truly  as 
does  the  mill  hand ;  but  the  thing  he  produces,  his  service,  has 
a  non-productive,  rather  than  a  productive,  destination. 

ILLUSTRATIVE  PROBLEM. 

"This  antithesis  of  productive  and  consumptive  is  all  non- 
sense anyhow.  So-called  productive  goods  are  merely  consump- 
tive goods  a  little  less  ripe.  The  destination  of  all  goods  is  to 
be  consumed, — to  contribute,  directly  or  indirectly,  to  the  satis- 
fying of  wants." 

(a)  Do  you  think  this  would  be  wholesome  doctrine  for  a 
young  man  without  any  property  starting  out  to  make  his  way 
in  life?    Explain. 

(b)  Use  this  to  illustrate  the  discussion  as  to  what  is  legiti- 
mate analysis  appearing  on  page  39. 

Section  E.    Capital  More  Particularly  Considered. 

In  our  discussion  of  the  economic  factors  of  production,  we 
necessarily  gave  considerable  attention  to  capital  because  of  the 
controversies  as  to  the  propriety  of  counting  it  at  all.  We 
could  not,  in  that  connection,  however,  make  our  treatment  any- 
thing like  adequate  without  rendering  it  almost  impossible  for  the 
student  to  get  a  comprehensive  view  of  the  whole  matter  of 
productive  factors.  Accordingly,  we  here  return  to  consider 
some  of  the  most  important  problems  connected  with  this  con- 
cept. 

1.     The  Special  Function  of  Capital  and  the  Capitalist. 

It  has  already  been  explained  in  a  general  way  that  capital, 
in  the  broader  sense,  has  two  functions  in  production,  viz., 
(1)  to  wait  and  (2)  to  assume  the  final  responsibility  of  pro- 
duction. The  second  of  these  is  perhaps  sufficiently  plain.  The 
first,  which  is  the  office  of  capital  in  the  narrowest  sense,  needs 
some  fuller  treatment. 

If  we  ask  ourselves  for  the  proximate  explanation  of  the 
superiority  of  capitalistic  methods,  we  find  it  chiefly  in  the  fact 
that  through  such  methods  man's  very  limited  powers,  capacities, 
are  reinforced  by  capacities  supplied  to  him  by  nature.  Thus,  he 
could  do  little  toward  cutting  down  a  tree  with  his  naked  hands ; 
but  those  same  hands,  armed  with  a  sharp  stone  or  later  with 
a  keen-edged  axe,  find  the  task  relatively  easy.  This  process  goes 
much  further  when  man  harnesses  to  his  tasks  great  elemental 
forces  like  gravitation,  as,  for  example,  when  he  employs  a 

G2 


CHAPTER  II.  ANALYSIS  OF  PRODUCTION 

water  power.  But,  now,  what  is  the  peculiarity  about  the  capi- 
talistic method  of  procedure  which  is  necessary  to  enable  it  to 
bring  to  our  aid  nature's  powers?  That  peculiarity  is  this,  that, 
in  using  said  method,  the  producer  reaches  his  goal  by  a  round- 
about path.  Instead  of  trying  directly  to  accomplish  his  object, 
he  first  does  several  other  things, — things  which  seem,  perhaps, 
very  little  related  to  his  ultimate  object,  but  which  are  after  all 
aimed  toward  that  object  in  the  strictest  sense.  Instead  of  try- 
ing to  get  down  the  tree  at  once,  a  man  first  sets  about  getting  an 
axe  with  which  to  do  the  work.  In  the  very  highly  specialized 
way  that  production  is  actually  carried  on,  the  woodman  does  not 
himself  make  the  axe  with  which  he  cuts  down  the  tree.  But, 
looking  at  society  as  a  whole,  the  cutting  of  the  tree  is  the  last 
of  a  long  series  of  processes  having  no  immediate  connection 
with  tree-cutting.  Iron  ore  has  to  be  gotten  out,  coal  also,  the 
latter  turned  into  coke,  this  used  with  the  ore  in  getting  out  pig 
iron,  this  transformed  into  steel  and  so  on.  Thus,  it  is  dis- 
closed that  roundaboutncss  is  a  necessity  of  the  capitalistic 
method. 

But,  again,  it  is  plain  that  a  roundabout  method  is  usually, 
if  not  always,  one  which  consumes  more  time  than  a  more  direct 
method.  Of  course,  this  does  not  mean  that  for  the  production 
of  a  certain  definite  amount — assuming  it  to  be  a  large  one — the 
roundabout  method  will  necessarily  prove  to  be  the  longer.  On 
the  contrary,  it  is  probable  that  in  the  .end  that  method  will  prove 
to  have  been  much  shorter.  But,  reckoning  from  the  time  when 
the  first  steps  toward  the  goal  are  taken  to  the  time  when  some 
returns,  however  small,  are  received,  the  roundabout  method  is 
almost  always  longer.  If  the  primitive  fisherman,  so  often  used 
for  illustration,  wants  food,  he  surely  can  get  some  in  a  much 
shorter  time  than  it  would  take  to  make  a  net  and  a  canoe  and 
then  use  these  to  catch  fish,  though,  of  course,  the  latter  method 
would  enable  him  to  catch  ten  thousand  fish  in  a  much  shorter 
time  than  he  could  by  some  more  direct  method.  If  now  it  be 
conceded  that  capitalistic  methods  are  usually  time-consuming 
methods,  it  follows  that  the  resort  to  these  methods  usually  in- 
volves for  producers  an  experience  which  to  most  persons  is 
more  or  less  of  a  sacrifice,  i.e.,  waiting, — we  must  endure  that, 
between  the  incurring  of  the  labor  sacrifices  involved  in  pro- 

63 


PRINCIPLES  OF  ECONOMICS 

duction  and  the  enjoyment   of  the   fruit  of  those   sacrifices,   a 
considerable  interval  shall  be  placed.* 

ILLUSTRATIVE  PROBLEMS. 

1.  Suppose  Mr.  A  has  produced  a  hundred  bottles  of  grape 
juice,  which  he  must  keep  for  ten  years  before  drinking  or  sell- 
ing it,  if  he  would  get  the  very  best  wine  out  of  it. 

(a)  If,  now,  Mr.  B  comes  along  and  offers  to  give  Mr.  A 
100  bottles  of  wine  which  had  already  been  aged  for  ten  years 
in  exchange  for  the  100  bottles  of  grape  juice,  who  would  be 
doing  the  waiting? 

(b)  What  other  costs  of  the  production  of  wine  would  he  be 
bearing? 

(c)  Suppose   Mr.    B   paid    Mr.   A   the    money   price   of    100 
bottles  of  wine  for  his  grape  juice,  say,  $100,  who  then  would 
do  the  waiting? 

(d)  If  Mr.   B  borrowed  the  $100  from  Mr.   C,  who  would 
do  the  waiting?     What  other  capitalistic  burden  would  remain? 
Who  would  bear  it? 

2.  Even  those  of  us  who  insist  that  it  is,  on  the  whole,  best 
to    distinguish    land    from   produced   intermediate   goods,    admit 
that  the  natural  working  of  the  laws  of  price,  for  the  time  be- 
ing,  transforms  land  into  capital.     Explain   this.      (A  piece  of 
land  yields  a  net  money  income  of,  say,  $100  for  an  indefinite 
number  of  years.    Will  it  be  worth  $100+$100+$100+$10(H-  and 
so  on  indefinitely?    If  not,  what  will  it  be  worth?) 

3.  One  is  sometimes  tempted  to  say  that  the  real  nature  of 
capital  is  best  brought  out  by   describing   it   as   the  power   to 
own  things.   Argue  for  the  usefulness  of  that  way  of  looking  at 
the  matter. 

4.  One  writer  is  disposed  to  find  the  essential  feature  of  cap- 
ital in  this  that  it  is  superfluous  wealth   to  its  owner, — wealth 
which   he  can   forego   using.     Show  that   this   helps   to  under- 
stand the  function  of  capital. 

2.     Is  Capital  Productive? 

Is  capital  productive?  Is  the  capitalist  a  producer?  These 
have  been  among  the  most  troublesome  questions  of  economic 
theory.  This  is  due  partly  to  the  inherent  difficulties  of  the 
matter,  partly  to  its  great  practical  significance.  In  the  actual 
world,  the  capitalist  proper,  i.e.,  the  person  who  does  the  wait- 
ing, and  the  entrepreneur  capitalist  have  always  received  a  very 
considerable  reward  for  their  reputed  share  in  production.  At 

*Doubtless,  this  element  of  waiting  is  in  some  degree  present  in  every 
form  of  production;  but  it  may  be  so  small  as  to  be  almost  negligible,  and 
in  so  far  as  it  is  present  in  any  particular  case,  the  method  of  production 
is,  strictly  speaking,  capitalistic. 

G4 


CHAPTER  II.  ANALYSIS  OF  PRODUCTION 

the  same  lime,  there  have  arisen,  in  all  ages,  many  protests  against 
this  order  of  things,  particularly  in  the  case  of  the  capitalist 
proper.  During  many  centuries,  governments  and  the  church 
stigmatized  as  wrong  the  taking  of  interest,  and  attempted  to, 
suppress  it  altogether.  In  modern  times,  the  attitude  of  the 
authorities  has  changed  and  interest-bearing  is  practiced  with 
general  approval.  Even  yet,  however,  a  considerable  section  of 
the  population— especially  the  advocates  of  socialism— believe 
that  the  capitalist  gets  a  return  to  which  he  has  no  valid  title. 
Naturally,  these  opponents  make  the  alleged  productivity  of  cap- 
ital their  chief  point  of  attack.  Labor  is  the  sole  factor  in 
production ;  capital  produces  nothing  and  so  has  no  right  to 
share  in  the  product, — is  their  contention.  In  addition  to  these 
opponents  of  interest,  there  are  not  a  few  professional  econo- 
mists who,  though  looking  on  interest  as  perfectly  legitimate, 
still  deny  that  we  can  properly  describe  capital  as  productive. 
It  is,  therefore,  almost  necessary,  even  in  an  elementary  course,, 
to  give  some  attention  to  the  problem. 

As  already  implied,  the  claim  that  capital  is  productive  is 
attacked  chiefly  by  two  groups,  vis.,  (l)  those  who  think  inter- 
est quite  wrong,  having  no  correspondence  to  any  service  of  the 
capitalist,  and  (2)  those  who  approve  interest,  attributing  to  the 
capitalist  a  service  but  not  one  which  can  properly  be  described 
as  productive.  As  between  economists  generally  and  the  first 
group,  the  difference  is  manifestly  very  real  and  fundamental; 
but,  as  between  those  who  frankly  call  the  capitalist  productive 
and  those  who  affirm  that,  although  he  performs  a  quite  necessary 
service  for  which  he  can  reasonably  claim  compensation,  still  the 
supplying  of  this  service  can  not  properly  be  designated  pro- 
duction, the  difference  is  obviously  one  of  mere  words,  or,  at 
best,  of  mere  theoretic  precision.  In  the  former  case,  it  seems 
necessary  to  go  into  the  matter  somewhat  fully.  We  can  hardly 
afford  to  leave  in  doubt  the  question  whether  capitalists  make  a 
contribution  to  the  productive  process.  The  second  controversy, 
however,  can  be  left  unsettled  without  materially  affecting  the 
student's  comprehension  of  elementary  economics.  Its  further 
consideration,  therefore,  will  for  the  present,  anyhow,  be  waived. 

Taking  up,  then,  the  quarrel  with  the  socialists,  does  the  cap- 
italist as  capitalist  perform  any  service, — make  any  contribution 
to  the  productive  process?  That  the  capitalist  is  a  producer  in 
one  sense,  vis.,  in  the  sense  that,  having  bought  the  capital  good, 

65 


PRINCIPLES  OF  ECONOMICS 

e.g.,  a  net,  he  represents,  performs  by  proxy,  the  labor  necessary 
to  produce  the  net,  and,  so,  may  reasonably  enough  be  credited 
ivith  so  much  of  the  product  as  is  naturally  credited  to  said  labor, 
— so  much  all  would  admit.  Thus,  if  the  net  costs  30  days  of 
labor,  lasts  90  days,  and,  in  that  time  enables  the  fisherman  to 
catch  9000  fish,  making  the  average  productive  capacity  of  the 
120  days  of  labor  75  fish,  then  no  one  would  object  to  saying 
that  the  net — and  so  the  capitalist  who  owns  it — produces  30 
times  75  fish  or  2250; — no  one  would  seriously  object  to  saying 
this,  though  the  socialist  would  prefer  to  say  that  the  30  days 
of  labor  used  in  making  the  net  really  produced  these  2250  fish. 
But  I  hardly  need  say  that,  in  claiming  that  the  capitalist  as 
capitalist  produces,  we  mean  something  more  than  this.  In  the 
actual  world,  the  net  or  its  owner,  would  be  credited  with  more 
than  2250  fish, — let  us  say  2520  fish.  But  this  would  leave  out 
of  the  9000  for  the  90  days  of  labor  used  in  catching  the  fish 
only  6480  or  72  fish  per  day.  But,  if  a  day's  labor  had  to  be 
content  with  72  fish  when  using  a  net,  it  would  have  to  take  the 
same  pay  when  making  one;  i.e.,  the  share  of  the  total  product 
credited  to  the  net  which  would  be  credited  to  the  labor  spent 
in  making  that  net  would  be  only  30  times  72  fish  or  2160.  Thus, 
out  of  the  2520  fish  going  to  the  net,  there  would  be  a  surplus 
of  360  which  would  be  credited  to  the  net  as  something  over 
and  above  the  labor  used  in  making  it.  This  is  something  like 
the  way  things  actually  ivork.  Now,  the  problem  before  us  is 
this:  Do  these  360  fish  which  are  credited  to  capital  as  capital 
represent,  in  some  sense  or  degree,  a  contribution  made  by 
capital  as  capital?  Granting  that  the  word  "produce"  is  not  a 
good  one,  that  the  360  fish  going  to  capital  as  capital  make  too 
large  a  share,  is  it  not,  after  all,  true  that  capital  as  capital, 
that  the  capitalist  as  capitalist,  has  made  some  contribution  to 
the  result?  It  seems  to  us  that  the  answer  must  certainly  be 
an  affirmative  one.  We  will  put  the  argument  for  it  into  a 
series  of  formal  propositions. 

'  (1)  Conceiving  capitalistic  production,  as  compared  with 
non-capitalistic,  to  be  merely  a  different  method  of  utilizing 
labor,  all  admit  that  it  is  a  more  efficient  method, — it  gives  a 
surplus  of  product  over  the  non-capitalistic  method.  (2)  The 
choice  of  the  more  efficient  capitalistic  method  involves  the 
choice  of  a  more  time-consuming  method.  (3)  The  choice  of 
this  more  time-consuming  method  necessitates  an  increase  of 


CHAPTER  II.  ANALYSIS  OF  PRODUCTION 

the  waiting-sacrifice  element  which  is  involved  in  all  produc- 
tion. (4)  To  this  increase,  (excess,  surplus)  of  the  waiting 
element  must  be  credited,  in  a  mere  physical,  technical  sense, 
the  increase  in  product  effected  by  the  capitalistic  method;  that 
is,  this  excess  of  the  waiting  phase  of  labor  must  be  described 
as  producing,  in  the  technical  sense,  just  as  truly  as  does  the 
effort  phase  of  labor.  (5)  Unless  the  supply  of  waiting  power 
is  so  great  that  we  do  not  need  it  all,  i.e.,  unless  it  is  practic- 
ally a  free  good,  such  as  air,  then  the  assuming  of  the  burden 
of  waiting  must  be  economically  credited  with  at  least  some 
part  of  the  increase  in  product  due  to  the  employment  of  the 
time-consuming  method.  (6)  Finally,  the  supplying  of  this 
condition — the  assuming  of  the  waiting  burden — is  undertaken 
by  the  capitalist  as  capitalist  and,  therefore,  the  product  credited 
to  waiting  must  be  credited  to  the  capitalist  as  capitalist. 

3.  Different  Kinds  or  Forms  of  Capital. 
Up  to  this  point  in  our  discussion  of  capital,  it  has  scarcely 
been  recognized  that  any  doubt  could  exist  as  to  just  what  ought 
to  be  meant  by  the  word  capital.  In  fact,  however,  there  is 
much  controversy  on  this  point.  It  would  probably  not  be  diffi- 
cult to  distinguish  as  many  as  twenty  different  definitions  of 
capital;  and  in  an  advanced  course,  we  could  hardly  pass  this 
point  without  making  a  more  or  less  thorough  study  of  the 
question:  How  ought  the  word  capital  to  be  defined?  But, 
at  present  such  study  would  probably  bring  more  confusion 
than  enlightenment.  Further,  that  study  is  the  less  necessary 
in  that  the  differences  of  opinion  on  this  matter  are  commonly 
much  less  important  than  at  first  sight  seems  to  be  the  case. 
In  fact,  the  same  person  may,  and  usually  does,  make  more  or 
less  use  of  several  of  the  meanings  which  he  formally  rejects. 
Accordingly,  we  shall  not  here  attempt  to  settle  the  question 
of  the  proper  definition  of  capital.  We  shall,  however,  discuss 
briefly  the  different  kinds  and  forms  of  capital;  and,  in  doing 
this,  we  shall  incidentally  bring  out  some  of  the  more  important 
variations  from  what  may  be  called  the  orthodox  definition  of 
the  term. 

(a)  The  definition  which  has  been  implied  thus  far  in  our 
discussion  and  which  probably  may  fairly  claim  to  be  the  most 
orthodox,  makes  capital  to  consist  of  intermediate  products,  or 
produced  goods  devoted  to  further  production.  Understanding 
capital  in  this  sense,  one  of  the  oldest  distinctions  is  between 

07 


PRINCIPLES  OF  ECONOMICS 

fixed  and  circulating  capital.  By  fixed  capital  is  meant  capital 
like  a  tool  or  a  machine,  which  gives  off  more  than  one  service. 
Circulating  capital,  in  contrast,  is  capital  which  does  its  part 
in  a  single  use, — gives  off  but  one  service,  e.g.,  the  raw  material 
used  in  making  a  wooden  box  or  the  coal  burned  in  a  steam 
engine. 

(b)  A    second    contrast    is    between    specialized    and    general 
capital.     Specialised  capital   is   capital   which    is   fitted   for    one 
purpose  only  or  anyhow  for  a  very  few  purposes,  e.g.,  a  planer, 
a    copper    stamper,    a    printing   press.*      Generalised    capital    is 
capital  which  can  be  put  to  any  one  of  many  uses,  e.  g.,  coal, 
pig  iron,  and,  most  of  all,  money. 

(c)  A    distinction    which   has    already  been   brought    out   in 
another   connection   is   between   formal    or    money   capital    and 
real  or  goods  capital.    The  fund  of  money  or  bank  credit  which 
the  true  capitalist  is  accumulating  and  which  he  or  some  bor- 
rower uses  to  buy  capital  goods  may  be  called  formal  capital; 
while  the  actual  goods,  the  engines,  machines,  coal,  etc.,  which 
are    being   produced   to    be    sold    for    the    money    fund    may   be 
called    the   real  capital.     Here,   however,   the   student   must   be 
careful  not  to  imagine  that  the  person  accumulating  the  money 
fund  is  not  producing  real  capital.    Ultimately,  he  is  responsible 
for  the  existence  of  the  real  capital,  the  engine,  machines,  etc. 
The  men  who,  literally  speaking,  produce  those  goods  are  virtu- 
ally only  his  agents.     In  a  very  important  sense,  he  is  himself 
producing    those    goods    and    lending    them    to    entrepreneurs, 
though    formally  he   lends   a   fund   of   money   to   entrepreneurs 
who  thereupon  buy  the  goods. 

(d)  The  preceding   distinction   of    formal   or  money   capital 
over  against  the  real  or  goods  capital  suggests  another  closely 
allied   one  between  invested  and  free   capital.     In  view  of  the 
fact  that,  in  the  present  order,  the  primary  form  in  which  capi- 
tal is  accumulated  is   a  fund   of  money,  it  is   natural,  perhaps 
inevitable,    that    the    process    of    devoting    capital    to    a    given 
enterprise  should  be  described  as  putting  it  into,  investing  it  in, 
the    said    enterprise.      Accordingly,    capital    which    has    already 
been  put  to  use  is  called  invested  capital ;  while  that  which  is 
waiting  to  be  put  to  use  is  called  free  capital.f 

(e)  Up  to  this  point,  we  have  had  in  mind  a  rather  narrow 


*The  term  fixed  capital  is  sometimes  used  in  this  sense, 
f  Also  frequently  called  idle  capital. 

68 


CHAPTER   II.    ANALYSIS    OF    PRODUCTION 

concept  of  capital,  viz.,  intermediate  goods,  products  devoted 
to  further  production.  If,  now,  we  broaden  our  use  of  the  term, 
as  almost  everyone  does,  to  include  all  goods  which  serve  their 
owner  indirectly,  i.  e.,  by  supplying  him  with  other  goods,  thus 
making  capital  synonomous  with  income-getting  goods,  then  it  be- 
comes necessary  to  recognize  another  distinction  between  social 
capital  and  private  or  acquisitive  capital.  By  the  former  is 
meant  the  kind  of  capital  usually  had  in  mind  in  preceding 
discussions,  i.  e.,  products  used  in  producing  other  products. 
Such  capital  is  income-giving  even  from  the  social  point  of 
view.  By  private  or  acquisitive  capital,  on  the  other  hand,  we 
mean  capital  which,  though  not  used  to  increase  the  total  volume 
of  goods  and  so  not  income-bearing  from  the  social  standpoint, 
does  yield  an  income  to  its  owner,  e.  g.,  a  gasoline  launch 
rented  to  a  summer-resorter. 

(f)  The    distinction    last    commented    upon    arose    because 
we  extended  the  concept  of  capital  somewhat  beyond  the  strict 
orthodox   limits.     Obviously,  we   shall  have  other  new  distinc- 
tions arising  if  the  concept  is  still  further  extended.     One  new 
way  of  conceiving  capital,  which  with  a  number  of  economists 
has  seemingly  displaced  the  old  idea  altogether,   makes  capital 
to  consist  of  a  -fund  of  value  embodied  in  the  things  commonly 
treated  as  capital  rather  than  to  consist  of  those  things  them- 
selves.    This   way   of   looking   at   the   matter   some   economists 
are  disposed  to  admit,  not  as  displacing  the  old   concept,  but 
as  a  more  or  less  useful  alternative.     In  such  case,  we  have  a 
new  distinction  of  pure  or  value  capital  and  concrete  or  goods 
capital.*    Even  those  who  doubt  the  soundness  of  this  distinction 
are  almost  compelled  to  use  it  more  or  less  on  account  of  the 
ambiguities   in   which   current   controversies    have   involved   the 
word  capital. 

(g)  Some   writers   are   disposed  to   extend  the  term  capital 
to   include   durable   products   even   when   these   are   devoted    to 
consumption,    e.   g.,   a    dwelling   house   occupied   by    its    owner. 
Though  there  is  doubtless  something  to  be  said  in  favor  of  this 
practice,  probably  most  of  us  think  the  older  usage  preferable. 
In  some  cases,  however,  we  may  find  it  convenient  to  speak  of 
producers'  capital,  meaning  the  kind   of  capital  originally  had 
in    mind,    and    consumers'    capital,    meaning    consumers'    goods 

*With  those  who  adopt  this  notion  of  capital  to  the  exclusion  of  the 
old,  only  value  capital  is  capital  at  all.  The  engine,  machines,  etc.,  are 
merely  capital  goods. 

69 


PRINCIPLES  OF  ECONOMICS 

which  have  a  durable  character,  last  for  a  long  time,  give  off 
many  uses. 

(h)  As  we  learned  earlier  in  the  chapter,  some  economists 
insist  on  including  land  along  with  the.  goods  usually  desig- 
nated capital.  This  fact  makes  it  convenient,  sometimes,  to 
distinguish  natural  and  artificial  capital. 

(i)  It  is  occasionally  convenient  to  speak  of  personal  capi- 
tal, meaning  the  bodily  or  mental  capacities  and  aptitudes  of 
human  beings ;  though  most  economists  consider  such  language 
figurative.  Capital  is  only  a  kind  of  wealth  or  wealth  looked 
at  in  a  particular  way.  But  personal  capacities,  not  being  trans- 
ferable, cannot  have  exchange  value,  hence  cannot  be  wealth, 
and,  therefore,  cannot  be  capital. 

ILLUSTRATIVE  PROBLEMS. 

1.  "Is  the  ordinary  laborer  in  any  sense  or  to  any  degree  a 
capitalist?" 

Give  two  or  three  reasons   for  an  affirmative  answer. 

2.  A  man,  let  us  suppose,  has  no  tools  besides  his  own  hands, 
but  uses  these  to  pull  the  weeds  and  grass   from  about  some 
wild  strawberry  plants  which  he  finds  already  established. 

(a)  Show  that   such  a   method   of  production   is   capitalistic. 

(b)  Show  that  it  is   capitalistic  in   that  it  involves  the   em- 
ployment  of   intermediate  products.     What   is   the    intermediate 
product  in  this  case? 

3.  One  man  performs  a  certain  amount  of  labor  in  connec- 
tion with  a  vineyard  and  has   for  sale  a  bottle  of  grape   juice 
worth  thirty-five  cents.     Another  man  does  an  equal  amount  of 
work,  then  waits  five  years,  and  has  a  bottle  of  wine  worth  one 
dollar   ($1.00). 

(a)  Show  that  the  second  process  is  more  capitalistic  than 
the  first. 

(b)  Precisely  why  does   the  more   capitalistic  method  prove 
more  efficient? 

4.  Question :  "How  is  it  that  capital  increases  the  efficiency 
of   industry?" 

Answer :  "Capital  is  necessary  to  enable  an  entrepreneur  to 
rent  a  site,  put  up  buildings,  and  buy  machinery  and  materials. 
Without  capital  he  could  not  produce  at  all.  So  of  course 
capital  increases  the  efficiency  of  industry." 

Show  that  the  answer  does  not  go  deep  enough. 

5.  Why  is  it  a  natural  metaphor  to  call  an  artist's  skill  his 
capita!  ? 


70 


CHAPTER  III. 

THE    CONDITIONS    AND    LAWS    OF    PRODUCTIVE 
EFFICIENCY. 

It  is  hardly  necessary  to  emphasize  the  point  that  all  are 
interested  in  maintaining  for  the  community  a  high  degree  of 
productive  efficiency.  Doubtless  the  extent  to  which  individ- 
uals profit  personally  from  such  efficiency  is  subject  to  great 
variation.  But  we  can  scarcely  conceive  any  one  so  situated  as 
to  gain  nothing  from  it.  Little  defense,  therefore,  is  needed 
for  giving  some  attention  to  this  topic.  Here,  however,  a  caution 
is  needed.  Political  Economy  does  not  attempt  an  exhaustive 
study  of  the  conditions  of  productive  efficiency.  Such  a  study 
rather  belongs  to  the  technical  arts,  agriculture,  mining,  engi- 
neering, etc.  Our  task,  in  contrast,  is  to  set  forth  the  more 
general  principles  governing  productive  efficiency. 

Section   A.    Capitalistic   Methods. 

In  another  connection,  we  have  already  brought  out  the 
nature  of  capitalistic  production  as  being  production  wherein 
intermediate  products  play  a  part  as  well  as  nature  and  labor. 
In  our  day,  practically  all  production  is  capitalistic  production. 
But  there  are  marked  differences  in  the  degree  to  which  the 
industries  of  a  particular  city,  or  country  are  capitalistic,  as 
compared  with  those  of  another  city  or  country,  as  also  in  the 
degree  to  which  particular  industries  of  one  country  are  capital- 
istic as  compared  with  other  industries  of  the  same  country.  A 
few  industries,  from  their  very  nature,  seem  unable  to  use  much 
capital.  But,  generally  speaking,  industries  can  commonly  use 
about  all  the  capital  they  can  get.  Further,  in  thus  increasing 
the  amount  of  capital  employed,  they  seem  able  to  increase  their 
efficiency  per  unit  of  land  and  labor.  The  principal  explanation 
of  this  increase  in  efficiency  was  brought  out  on  pages  .  .,  vis., 
the  fact  that  through  the  roundabout  method  we  are  able  to 
reinforce  our  powers  with  nature's  powers.  In  the  beginnings 
of  industry,  the  gain  thus  achieved  by  introducing  methods  which 
are  more  capitalistic  is  simply  enormous ;  e.g.,  making  a  net  and 


PRINCIPLES  OF  ECONOMICS 

boat  and  using  these  in  catching  fish  instead  of  depending  on 
one's  hands  alone.  Even  in  later  stages  of  development,  some 
invention  like  the  dynamo  will  give  a  startlingly  great  increase 
to  our  productive  efficiency.  This  truth  with  respect  to  our 
dependence  on  capitalistic  methods  for  high  industrial  efficiency 
is  so  familiar  as  to  need  little  comment.  Still  it  is  not  infre- 
quently overlooked  in  times  of  popular  excitement;  and  legis- 
lative measures  are  adopted  and  enforced  which  discourage  the 
accumulation  of  capital  or  drive  it  out  of  the  community.  It  is, 
therefore,  needful  to  have  the  general  principle  in  mind. 

Principle.  In  general,  the  productive  efficiency  of  any  com- 
munity varies*  directly  as  the  extent  to  which  it  employs  capi- 
talistic methods. 

Section  B.     Specialized  or  Heterogeneous  Cooperation. 

We  have  already  seen  that  the  present  economic  order  is 
essentially  a  cooperative  one,  though  the  form  of  cooperation 
carried  out  in  it  is  spontaneous  rather  than  conscious  and  formal. 
We  have  also  seen  that  most  of  the  gain  resulting  from  this 
cooperation  is  from  the  heterogeneous  form,  i.e.,  the  form  in 
which  one  person  supplies  one  element;  another  person,  another 
element;  and  so  on,--in  other  words>  the  form  of  cooperation  in 
which  there  is  specialization.  This  specialization,  I  hardly  need 
say,  applies  not  only  to  labor  but  also  to  land  and  capital — 
though  the  conventional  phrase,  "division  of  labor,"  suggests 
that  we  have  to  do  only  with  labor  specialization.  The  student 
will  have  no  difficulty  thinking  of  many  illustrations  of  land  and 
capital  specialization.  Putting  into  formal  shape  this  fact  that 
specialized  cooperation  increases  productive  efficiency,  we  have 
the  following 

Principle.  In  general,  the  productive  efficiency  of  any  com- 
munity varies  directly  as  the  extent  to  which  specialization  in  the 
use  of  the  different  factors  of  production  is  carried. 

Among  the  considerations  which  explain  the  superior  efficiency 
of  methods  involving  such  specialization,  the  following  are  of 
importance. 

(1)  Specialization  utilizes  all  instruments  and  agents,  even 
the  inferior  ones. 

*In  economics,  the  phrase  "varies  as"  does  not  involve  proportionate 
variation.  "To  vary  directly  as"  means  to  vary  in  the  same  direction, 
though  not  necessarily  to  the  same  degree.  "To  vary  inversely  as"  means 
to  vary  in  the  opposite  direction,  though  not  necessarily  to  the  3<»me  degree. 

72 


CHAPTER   III.     PRODUCTIVE   EFFICIENCY 

(2)  It  utilizes  superior  instruments  and  agents   most  fully. 
(The  instrument  capable  of  large  work  is  not  wasted  on  small 
things.) 

(3)  It  utilizes  natural  aptitudes  (applying  to  lands  and  men). 

(4)  It  permits  the  creation  of  artificial  aptitudes   (applying 
to  intermediate  products  and  men). 

(5)  It  economizes  in  time  (applying  to  machines  and  men). 

(6)  It  shortens  apprenticeship  (applying  to  men). 

(7)  It  stimulates  invention  and  other  improvements. 

It  will  be  an  excellent  exercise  for  the  student  to  work  out 
illustrations  of  each  of  these  advantages  of  specialization. 

The  preceding  discussion  has  emphasized  the  fact  that  special- 
ization— specialized  cooperation — contributes  greatly  to  productive 
efficiency.  But,  if  specialized  cooperation  is  conducive  to  produc- 
tive efficiency,  then  of  course  any  condition  which  is  requisite  to 
such  cooperation  is  conducive  to  productive  efficiency.  Now,  as 
brought  out  at  the  very  beginning  of  our  study,  exchange  is  such 
a  requisite; — under  the  present  order  cooperation  is  made  pos- 
sible through  exchange,  trade.  In  order,  then,  to  take  advantage 
of  the  principle  that  specialization  increases  efficiency,  we  must 
exchange  products  with  one  another.  But,  further,  the  extent  of 
the  possible  specializing  is  limited  by  the  extent  of  the  exchang- 
ing. If  we  trade  with  only  a  few  people  the  need  for  a  single 
kind  of  goods  will  be  too  small  to  justify  setting  some  one  per- 
son to  producing  that  kind  only.  The  amount  wanted  will  not 
keep  him  busy.  Hence,  we  have  the  following 

Principle.  The  extent  to  which  specialization  can  profitably 
be  carried  varies  directly  as  the  extent  of  the  market. 

An  obvious  deduction  from  the  principle  just  laid  down  is  that 
anything  which  hinders  trade  between  our  town  and  other  towns, 
or  our  state  and  other  states,  or  our  country  and  other  countries, 
diminishes  our  productive  efficiency  in  that  it  narrows  the  market 
of  whrvh  we  form  a  part  and  so  diminishes  the  extent  to  which 
we  can  carry  specialization.  Hence  we  have  the  following 

Corollary.  High  productive  efficiency  depends  on  a  large 
amount  of  freedom  of  trade. 

It  has  not  been  possible  to  get  thus  far  in  our  discussion  of 
economic  principles  without  bringing  out  by  implication  one  of 
the  principal  reasons  why  economists  as  a  class  are  free  traders : 

73 


PRINCIPLES  OF  ECONOMICS 

—they  favor  the  utmost  possible  freedom  from  restrictions,  be- 
cause this  means  the  largest  possible  amount  of  cooperation, — it 
enables  every  one  to  benefit  most  completely  by  the  productive 
activity  of  every  one  else.  But,  while  economists  generally  favor 
the  utmost  possible  freedom  of  trade,  we  are  all  well  aware  that 
such  freedom  is  decidedly  the  exception  rather  than  the  rule. 
Further,  -all  economists  would  admit  that  this  freedom  is  more 
important  in  some  cases  than  in  others;  just  because  trade  is 
more  important  in  some  directions  than  in  others.  It  would  be 
foolish  to  put  an  import  duty  on  hay ;  but  then  it  would  do 
comparatively  little  harm  for  some  years,  since  we  do  not  nat- 
urally buy  much  hay  outside  our  own  country.  Doubtless  the 
economist  would  say  that  the  trade — exchange-cooperation — which 
goes  on  of  its  own  accord  is  the  truly  advantageous  one ;  so  that 
we  need  not  worry  ourselves  about  the  questions  why  and  when 
is  such  trade  advantageous,  but  would  better  simply  leave  the 
matter  alone.  But,  whatever  economists  think,  governments 
continue  to  try  to  guide  our  trade  into  more  or  less  artificial 
channels.  In  doing  this,  they  profess  to  act  on  the  basis  of 
principles.  We  have  no  intention  of.  undertaking  here  a  study  of 
these  principles.  But  one  or  two  of  them  belong  to  our  present 
topic  in  that  they  concern  directly  the  question — When  is  ex- 
change-cooperation, trade,  between  different  countries  profitable? 
To  which  question,  therefore,  we  must  now  give  a  little  attention. 

One  general  condition  under  which  exchange-cooperation 
would  surely  be  profitable  would  be  realized  if  two  communi- 
ties, Ci  and  C2,  produced  just  two  things,  Pi  and  P2,  and  Ci 
could  produce  Pi  much  more  cheaply  than  could  G,  while  C2 
could  produce  P2  much  more  cheaply  than  could  Ci.  Evidently 
both  would  gain  if  Ci  should  produce  enough  Pi  for  both,  and  C2 
enough  P2  for  both.  On  the  basis  of  this  case,  we  might  say  that 
exchange  will  usually  pay,  if  each  of  the  exchanging  countries 
can  produce  some  particular  thing  much  more  cheaply  than  the 
other;  and  very  likely  the  most  important  cases  of  profitable 
trade  would  be  covered  by  saying  that,  when  a  country  is  abso- 
lutely superior  to  its  neighbors  in  producing  the  goods  it  ex- 
ports and  is  absolutely  inferior  in  producing  the  goods  it  imports, 
such  export  and  import  is  profitable. 

But,  while  the  most  important  cases  of  exchange-cooperation 
between  countries  would  probably  be  covered  by  such  a  prin- 
ciple, fuller  analysis  long  ago  showed  that  this  state- 

74 


CHAPTER  III.     PRODUCTIVE   EFFICIENCY 

ment  does  not  cover  all  cases,  is  in  fact  misleading. 
If  we  stopped  at  this,  the  reader  might  very  naturally 
conclude  that  trade  would  pay  only  when  the  condition 
just  explained  was  present.  He  might  even  conclude  that  we 
ought  never  to  buy  a  thing  from  other  countries  if  we  could 
produce  that  thing  as  cheaply  as  those  other  -countries.  This 
notion,  though  quite  wrong,  is  quite  common.  Thus,  not  long 
ago  I  had  a  conversation  with  a  near  neighbor  which  drifted 
into  a  discussion  of  Protection  and  Free  Trade.  The  point  which 
my  neighbor  was  particularly  disposed  to  insist  upon  was  brought 
out  in  language  something  like  this:  "Of  course  I  am  glad  to 
see  the  United  States  buy  coffee  of  Brazil,  for  we  can  not  pro- 
duce coffee  at  all.  For  that  matter,  I  am  willing  to  see  our 
people  buying  silks,  wines,  and  many  other  things  I  could  men- 
tion, because  other  countries  can  produce  those  things  better 
than  we  can.  But  the  case  of  steel  is  a  very  different  thing.  I  do 
not  admit  that  there  is  any  country  under  the  sun  that  can 
produce  steel  any  better  than  America  can,  so  I  am  down  on 
any  tariff  that  lets  in  steel  of  foreign  manufacture."  Now, 
the  unsoundness  of  the  doctrine  as  applied  to  the  case  of  an 
individual  is  at  once  evident.  Here,  for  example,  is  a  lawyer  who 
very  likely  can  mow  his  lawn,  cultivate  his  garden,  and  take  care 
of  his  furnace  much  better  than  the  person  or  persons  whom  he 
hires  to  do  these  things.  But  what  he  does  is  to  devote  himself 
to  the  practice  of  his  profession,  and  buy  the  services  named 
from  other  people;  and  of  course  acts  wisely  in  doing  so.  Put 
in  simple  language,  it  is  plain  that  he  gains  most  by  devoting 
himself  to  the  doing  of  the  thing  for  which  he  is  best  fitted,  at 
which  he  can  make  the  most  money.  He  is  not  interested  in 
the  fitness  or  unfitness  of  his  neighbor  as  compared  with  him- 
self, but  rather  in  the  superiority  of  his  own  fitness  in  one  line 
as  compared  with  his  fitness  in  another  line.  So  long  as  he  can 
find  a  market  for  his  possible  output,  he  would  better  devote 
his  time  entirely  to  doing  the  thing  for  which  he  is  preeminently 
fitted,  and  get  his  supplies  of  other  things  from  his  neighbors, 
even  though  he  can  make  those  other  things  better  than  his 
neighbors. 

Now,  it  seems  pretty  evident  that  the  case  of  a  community  or 
nation  is  in  this  respect  no  different  from  that  of  an  individual. 
The  Upper  Peninsula  of  Michigan  produces  little  but  copper  and 
iron,  getting  most  other  goods  through  exchange  with  other 


PRINCIPLES  OF  ECONOMICS 

communities.  Yet  it  would  be  easy  to  prove  that  Upper  Mich- 
igan is  really  better  fitted  to  produce  some  of  these  things  which1 
she  buys  from  the  rest  of  us  than  we  are,  and  that  her  people 
are  quite  aware  of  this.  It  is  therefore  necessary  to  find  some 
other  explanation,  of  her  action  than  the  one  commonly  put 
forth  by  the  public.  This  explanation  is  to  be  found  in  what  has 
been  long  known  as  the  Law  of  Comparative  Cost. 
Principle.  The  Law  of  Comparative  Cost. 

Ignoring  cost  of  transportation,  two  communities  (persons) 
find  it  profitable  to  specialize  respectively  in  the  production  of 
two  commodities  and  to  exchange  those  commodities  each  for  the 
other,  provided  the  comparative  real  costs  of  the  two  commod- 
ities in  one  community  are  different  from  their  comparative  real 
costs  in  the  other  community. 

Illustration :  Letting  labor  represent  all  real  costs,  suppose 
that  in  England  the  cost  of  a  ton  of  iron  is  25  days'  labor  and 
the  cost  of  a  yard  of  broadcloth  is  5  days'  labor;  while  in 
America  the  cost  of  the  iron  is  16  days'  labor  and  that  of  the 
broadcloth  4  days'  labor. 

Eng.  cost  Iron   :  Eng.  cost  Cloth   : :  25   :  5 
Am.  cost  Iron    :  Am.  cost  Cloth   : :  16  :  4 

The  comparative  costs  are  not  equal;  therefore,  by  the  principle, 
specialization  and  exchange  will  pay. 

Argument :  Since  in  England  a  ton  of  iron  costs  five  times  as 
much  as  a  yard  of  cloth,  it  will  naturally  tend  to  be  worth  the 
same  as  five  yards  of  cloth ;  under  which  conditions  England  can 
afford  to  give  iron  for  cloth  if,  and  only  if,  she  can  get  more 
than  five  yards  per  ton;  or  trade  cloth  for  iron  if,  and  only  if, 
she  can  get  it  with  less  than  five  yards  per  ton.  In  America,  on 
the  other  hand,  a  ton  of  iron  tends  to  be  worth  four  yards  of 
cloth;  under  which  conditions  America  can  afford  to  trade  iron 
for  cloth  if,  and  only  if,  she  can  get  more  than  four  yards  per 
ton;  or  to  trade  cloth  for  iron  if,  and  only  if,  she  can  get  it  with 
less  than  four  yards.  But  the  first  hypothesis  for  England  and 
the  second  for  America  are  plainly  shut  out.  England  can  not  get 
more  than  five  yards  of  cloth  for  iron,  since  in  America  it  is 
worth  only  four  yards.  So  America  can  not  buy  iron  with  less 
than  four  yards  of  cloth  since  it  is  worth  five  yards  in  England. 
On  the  other  hand,  the  second  hypothesis  for  England  and  the 
first  for  America  fit  each  other  perfectly.  England  can  get  iron 

7G 


CHAPTER   III.     PRODUCTIVE   EFFICIENCY 

for  less  than  five  yards,  since  it  is  worth  only  four  in  America ; 
and  America  can  sell  iron  for  more  than  four  yards  of  cloth, 
since  it  is  worth  five  in  England.  Accordingly,  under  the  con- 
ditions supposed,  an  exchange  of  English  cloth  for  American 
iron  would  be  profitable. 

Note:  The  above  statement  of  the  Principle  of  Comparative 
Cost  puts  it  in  terms  of  the  reciprocal  trade  of  two  countries. 
But  in  fact  most  international  trade  is  not  of  this  two-fold 
character.  It  is  triangular  or  multiangular.  Nation  A  sells  to 
B;  B  sells  to  C;  and  C  sells  to  A.  At  bottom,  however,  the 
cases  are  substantially  alike.  The  condition  which  make  special- 
ization and  exchange  profitable  is  a  difference  between  the  com- 
parative costs  to  one  country  of  the  things  exchanged  and  their 
comparative  costs,  to  other  •  countries.  However,  the  complete 
demonstration  of  this  proposition  would  occupy  a  good  deal  more 
time  than  we  can  spare  and  so  must  wait  a  more  favorable 
season. 

Corollary  1.  If  one  nation  is  absolutely  inferior  to  its  neigh- 
bors in  respect  to  the  production  of  one  commodity  and  abso- 
lutely superior  in  respect  to  the  production  of  another,  then, 
obviously,  the  comparative  costs  of  these  commodities  in  this 
country  are  different  from  their  comparative  costs  outside,  and 
so  exchanging  them  will  pay. 

This  corollary  brings  out  the  fact  that  the  Law  of  Compara- 
tive Cost  includes  the  general  point  first  made  that  trade  between 
two  countries  will  pay  provided  each  is  superior  to  the  other 
in  respect  to  some  commodity. 

Corollary  2.  If  a  nation  is  absolutely  superior  to  its  neigh- 
bors in  the  production  of  each  of  two  commodities,  but  its 
superiority  is  greater  in  respect  to  one  than  in  respect  to  the 
other,  it  will  profit  by  producing  the  former  and  importing  the 
latter. 

Corollary  3.  If  a  nation  is  absolutely  inferior  to  its  neigh- 
bors in  the  production  of  each  of  two  commodities,  but  its 
inferiority  is  less  in  respect  to  one  than  in  respect  to  the  other, 
then  it  will  profit  by  producing  the  former  and  importing  the 
latter. 

ILLUSTRATIVE  PROBLEMS. 

1.  In  most  economic  text  books,  one  meets  the  phrase 
"geographical  division  of  labor." 

(a)  What  do  you  suppose  it  means? 

(b)  Give  some  illustrations  of  it. 

77 


PRINCIPLES  OP  ECONOMICS 

2.  Give  some  examples  of  recently  developed  labor  special- 
ization,— if  possible  from  your  own  observation. 

3.  Same  as  Problem  2  for  capital. 

4.  Why  is  it  that  a  country  store  keeps  a  little  of  every- 
thing, while  a  city  store  very  often  deals  in  only  one  kind  of 
commodity,  e.g.,  shoes  or  china  or  sporting  goods. 

5.  Country  A  can  produce   pig  iron  at  a  cost  of  10  days' 
labor  per  ton   and  broadcloth  at  a  cost  of  5   days'   labor  per 
yard.     Country  B  can  produce  the  iron  at  a  cost  of  14  days' 
labor  and  the  cloth  at  a  cost  of  6  days'  labor. 

(a)  What,  in  this  example,  are  the  comparative  costs  which 
our  principle  tells  us  must  be  unequal  to  make  exchange  pay? 

(b)  Prove   in    detail    that,    if    transportation   and    all    costs 
other   than  labor  be   ignored,   exchange  of   these  two  products 
will  pay. 

(c)  Which  commodity  will  country  A  export? 

6.  Make  a  hypothetical  case  yourself  and  prove  with  it  that 
exchange  will  not  pay  if  comparative  costs  are  equal. 

7.  It   is    sometimes    said    that   nowadays    almost    everything 
is  produced  for  a  world  market. 

(a)  What  is  one  of  the  greatest  gains  of  having  such  a 
market? 

(b)  What  are  some  of  the  most  important  industrial  changes 
which  have  made  it  possible? 

(c)  Suggest  one   or    two   of   the   most   serious   evils   which 
would  naturally  result  from  it. 

8.  "We  may  often  by  trading  with   foreigners,   obtain  their 
commodities  at  a  smaller  expense  of  labor  and  capital  than  they 
cost  the  foreigners  themselves." — Sumner. 

(a)  Show  with  illustration  that  this  is  true. 

(b)  S'how  how  such  a  trade  could  be  profitable  to  the  foreigner. 

(c)  What  do  you  suppose  is  the  ultimate  cause  which  ex- 
plains the  fact  that  such  trade  can  be  profitable? 

9.  "We  know   that  England  can   make  ships   more  cheaply 
than  we  can,  and  so  we  should  let  her  do  the  ship  building  and 
turn  our  capital  to  such  things  as  we  can  do  better  than  she  can." 
Assuming   the   conclusion — that  we   should   turn   our   capital   to 
other    things — to    be    correct,    the    reason    given    for    it    is    not 
entirely  satisfactory.    Explain. 

Section  C.    Large  Scale  Production 

It  is  a  fact  familiar  to  us  all  that  the  extraordinary  industrial 
progress  of  the  last  one  hundred  years,  and  particularly  of  the 
last  twenty-five  years,  has  been  accompanied  by  a  great  expansion 
in  the  scale  on  which  industry  is  conducted.  Further,  it  is 
generally  recognized  that  in  no  small  measure  these  have  been 

73 


CHAPTER   III.     PRODUCTIVE   EFFICIENCY 

related  as  effect  and  cause.  The  progress  has  largely  resulted 
from  the  enlarged  scale  of  industrial  operations.  The  big 
store,  the  big  factory,  the  big  railroad  is  able  to  supply  its 
particular  product  at  much  smaller  cost  and  often  of  much  better 
quality.  Formally  stated  this  gives  us  the  following 

Principle.  In  general  the  efficiency  of  industrial  units  varies 
directly  as  'their  size. 

Among  the  principal  reasons  for  this  superiority  of  large 
scale  production  are  the  following: 

(a)  Large  scale  production  permits  a  great  extension  of  the 
policy  of  specialization  in  that  it  makes  the  number  of  neces- 
sary operations  of  any  particular  sort  sufficiently  large  to  keep 
a  machine  or  man  busy  on  that  sort  alone. 

(b)  Large  scale  production  secures  economy  in  the  use  of 
different  factors,  instruments.     (1)     At  certain  points  specializa- 
tion must  be  carried  almost  as  far  in  the  small  concern  as  in 
the  large  one;  and  the  large  one  permits  a  fuller  utilization  of 
the  specialized  factor.     (2)     In  the  stock  of  raw  materials,  tools, 
and  finished  products  there  must   always  be  some  reserves   to 
meet  contingencies.     The   reserves   of   a  particular   concern   do 
not  need  to  be  five  times  as  large  as  those  of  another  concern 
though  the  business  of  the  former  is  five  times  as  large. 

(c)  Large  scale  production  makes  it  possible  to  utilize  waste 
products. 

(d)  Large  scale  production  insures  better  bargains  when  the 
concern  comes  on  the  market  as  a  buyer  or  seller. 

Caution :  There  seems  to  be  a  more  or  less  definite  limit  to 
the  size  of  the  unit  which  can  be  effectively  worked.  This  limit 
varies  in  different  industries,  at  different  times,  and  in  different 
countries.  It  is  soonest  reached  in  respect  to  the  physical  unit, 
the  plant.  It  comes  much  later  in  respect  to  the  organization 
unit,  the  unit  viewed  as  under  one  control  in  respect  to  manage- 
ment, accounts,  buying  and  selling,  etc.  There  is  probably  a 
limit,  however,  at  this  point.  A  concern  may  become  so  large 
that  the  securing  of  honest  and  efficient  management  is  well- 
nigh  impossible. 

ILLUSTRATIVE  PROBLEMS. 

1.  Some  of  the  big  farms  of  East   Prussia  have  their  own 
little  railways,  locomotives,  cars,  etc.     What  advantage  of  large 
scale  production  does  that  illustrate? 

2.  Suppose  that  the  five   banks  of  Ann  Arbor  were  to  be 


PRINCIPLES  OF  ECONOMICS 

united  into  one  and  that,  while  each  of  the  uniting  banks  em- 
ploys a  cashier,  a  teller,  a  book-keeper,  and  a  messenger,  the 
consolidated  bank  were  to  employ  a  cashier,  a  paying-teller,  a 
receiving  teller,  a  discount-clerk,  a  collection-clerk,  a  head  book- 
keeper, an  assistant  book-keeper,  and  a  messenger.  Show  that 
the  facts  as  stated  illustrate  two  gains  of  large  scale  industry. 

3.  "If  the  four  or  five  dry-goods  stores  on  Main  street  were 
united,  a  great  saving  in  the  fund  of  circulating  capital  required 
in  that  business  would  be  effected."  (Circulating  capital  means 
capital  out  of  which  we  get  but  one  use,  like  food,  or  fuel,  or 
goods  which  the  merchant  buys  to  sell  again.  In  contrast,  fixed 
capital  gives  off  many  uses,  and,  of  course,  remains  in  our  hands 
some  time;  e.g.,  the  showcases  of  the  merchant.  The  things  in 
the  showcases  are  circulating  capital.) 

(a)  Argue  for  the  truth  of  the  quotation. 

(b)  Show  that  the  new  plan  would  probably  effect  a  saving 
in  iixed  capital  also. 

Section   D.     Industrial  Freedom 

When  the  French  Revolution  broke  out  in  the  last  years  of 
the  eighteenth  century,  it  found  most  of  the  Western  nations 
dominated  by  governments  which  exercised  a  very  complete 
despotism,  not  only  in  respect  to  matters  commonly  regarded  as 
well  within  the  proper  scope  of  political  action,  but  also  in 
respect  to  economic  matters.  Indus-try  was  regulated  in  the 
minutest  way, — the  amount  each  establishment  could  produce,  the 
kind  of  stuff  it  should  use,  the  methods  of  manufacture, 
(the  number  of  threads  to  the  square  yard  in  cloth),  these  and 
many  other  matters  were  rigidly  fixed  by  law  and  the  regula- 
tions were  enforced  with  great  severity.  It  is  probably  true  that 
in  its  beginning  this  excessive  interference  with  the  spontaneous 
course  of  industry  was  more  or  less  justified;  but  there  early 
developed  among  business  men  and  thoughtful  students  the 
notion  that,  as  carried  out,  this  policy  was  not  only  annoying 
and  more  or  less  inconsistent  with  our  notions  of  right,  but  also 
a  real  hindrance  to  the  attainment  of  the  result  sought.  Nations 
were  actually  made  less  efficient  and  so  poorer  by  the  very 
means  intended  to  make  them  efficient  and  rich.  For  various 
reasons  this  notion  came  to  be  widely  accepted  and  incorporated 
into  government  policy  near  the  end  of  the  eighteenth  century 
or  in  the  early  years  of  the  nineteenth.  And,  whether  as  a  re- 
sult of  this  change,  or  from  other  reasons,  or  from  a  combination 
of  both,  industry  advanced  at  a  quite  unparalleled  pace.  In  con- 

80 


CHAPTER   III.     PRODUCTIVE   EFFICIENCY 

sequence,  economists  have  come  quite  generally  to  hold  the 
opinion  that,  whatever  objections  there  may  be  to  it  on  other 
grounds,  industrial  freedom  anyhow  contributes  to  efficiency. 
Hence  the  following 

Principle.  In  general,  industrial  efficiency  is  greater  under 
a  regime  of  freedom,  non-interference,  laissez  faire,  than  under 
one  of  much  governmental  regulation. 

Arguments :  (a)  Considerable  freedom  of  trade,  anyhow,  is 
necessary  if  we  are  to  have  that  thorough-going  specialization 
which,  as  we  have  seen,  contributes  greatly  to  industrial  efficiency. 

(b)  Generally   speaking,    under    freedom,   the    direction   of 
industrial  forces  will  be  such  as  to  secure  the  highest  efficiency. 
(1)     As  a  rule,  individuals  will  be  better  able  than  any  one  else 
to  decide  what  they  are  best  fitted  to  do.     (2)     Individuals  will 
have  the  strongest  motives  for  seeing  that  they  are  doing  those 
thing's;   since,   however  much  advantage   such   a   course  brings 
to  society  at  large,  it  brings  still  more  to    the  individuals  them- 
selves. 

(c)  The  stimulus  of  competition,  emulation,  is  greatest  under 
a  regime  of  freedom. 

(d)  The  moral  qualities  requisite  to  efficiency, — self-reliance, 
decision   of   character,   energy,   industry,   etc.,   are   most   highly 
developed  under  freedom. 

Caution.  (1)  Advocates  of  non-interference  have  always 
recognized  that  more  or  less  govermental  interference  will  al- 
ways be  necessary  to  secure  the  very  industrial  liberty  they 
wish  to  see  prevail ;  since  this  liberty  is  liable  to  be  restricted  by 
private  action,  e.g.,  by  the  action  of  monopolistic  combinations. 
In  our  day  it  has  been  found  necessary  to  extend  governmental 
action  very  far  on  this  ground, — i.e.,  to  extend  that  action  in 
order  to  hinder  private  persons  from  encroaching  on  industrial 
freedom. 

(2)  With  the  growth  of  popular  control  over  govermental 
action,  it  has  been  found  expedient  to  increase  the  activity  of 
governments  in  directions  which  contribute  indirectly  to  indus- 
trial efficiency,  e.g.,  perfecting  means  of  communication,  supply- 
ing weather  information,  investigating  industrial  methods,  partic- 
ularly in  the  fields  where  there  seems  to  be  a  lack  of  private 
iritiative  (agriculture),  and  so  on. 

(3)  Experience  under  the  laissez  faire  regime  soon  showed 
that  the  high  industrial  efficiency  secured  by  freedom  might  be 
purchased  at  too  high  a  price.     Excessive  labor  of  women  and 
children,  physical  injuries   from  improperly  guarded  machinery, 
and  so  on,  called  for,  and   secured,  much  remedial   legislation. 

81 


PRINCIPLES  OF  ECONOMICS 

At  the  present  time  there  are  still  many  abuses  incident  to  great 
industrial  liberty,  the  correction  of  which  is  much  more  important 
than  the  high  efficiency  derived  from  that  liberty.  It  is  probable, 
therefore,  that  for  some  time  we  shall  not  see  less,  but  more, 
governmental  interference  with  industry.  Nevertheless,  it  still 
holds  good  that  non-interference  contributes  to  efficiency,  and 
statesmen  should  carry  out  the  needed  control  with  a  minimum 
of  interference. 

Section   E.     Integration   of  Industries. 

In  the  preceding  sections,  we  have  discussed  the  conditions  of 
productive  efficiency  with  regard  to  which  there  is  much  con- 
firmatory experience  and  comparatively  little  difference  of 
opinion.  In  this  and  the  following  sections  we  meet  two  alleged 
methods  of  increasing  efficiency  which  are  of  recent  origin  and, 
in  many  minds,  of  doubtful  value.  One  of  these  has  been 
named  the  Integration  of  Industries.  (See  article  in  the  Quar- 
terly Journal  of  Economics,  vol.  16,  p.  94.)  This  new  departure 
consists  in  the  bringing  together  under  one  control  of  dissimilar 
but  interdependent  industries;  e.g.,  a  steel  producer's  under- 
taking to  own  and  run  iron  mines,  coal  mines,  coke  ovens,  pig 
iron  furnaces,  auxiliary  railways,  etc.  This  case  of  steel  produc- 
tion was  one  of  the  first  great  applications  of  the  principle; 
and,  as  all  know,  it  was,  and  is,  eminently  successful.  There 
seems  little  doubt,  therefore,  that  the  practice  of  thus  combining 
interdependent  industries  is  adapted,  in  some  cases  anyhow, 
to  increase  productive  efficiency.  Hence  we  are  probably  safe 
in  laying  down  the  following 

Principle.  In  many  cases,  industrial  efficiency  is  increased  by 
bringing  interdependent  industries  under  one  control. 

Reasons:  (1)  Integration  makes  it  possible  to  realize 
more  fully  the  gains  natural  to  large  scale  production.  (2) 
Integration  secures  a  variety  of  economies  due  to  the  comple- 
mental  nature  of  the  industries  integrated,  particularly  in  that 
each  of  these  industries,  save  the  lowest,  provides  a  market  for 
the  product  of  some  other  member  of  the  series  and  so  •  saves 
advertising  and  other  selling  expenses,  diminishes  the  risk 
burden,  etc. 

Section  F.     The  Unification  of  Industries:   Consolidation, 
Combination. 

A  very  characteristic  development  of  industry  during  the 
last  twenty  years,  particularly  in  the  United  States,  is  the 

82 


CHAPTER  III.     PRODUCTIVE  EFFICIENCY. 

coalescing,  combining,  of  hitherto  independent  industrial  units 
of  the  same  kind  into  a  single  all-inclusive  unit.  Such  units 
are  commonly  known  as  trusts,  or,  in  popular  phraseology,  com- 
bines. The  practice  illustrated  in  their  organization  is  contrasted 
with  that  covered  in  the  preceding  section  under  Integration,  in 
that  the  latter  combines  dissimilar,  though  interdependent,  units; 
while  trusts  combine  similar  units.  An  integration  puts  to- 
gether coal  mining,  iron  mining,  pig  iron  making,  steel  making, 
etc.  A  trust  puts  together  the  American  Steel  Company,  the 
Carnegie  Steel  Company,  the  Illinois  Steel  Company,  etc. 

Now  it  is  fairly  evident  that  the  formation  of  a  trust  must 
in  most  cases  realize  one  of  the  conditions  of  high  efficiency 
already  considered,  i.e.,  largeness  of  scale,  and,  hence,  it  must 
so  far  tend  to  increase  productive  efficiency.  Thus,  the  combina- 
tion bank  in  Problem  2,  p.  79,  which  takes  the  place  of  five 
independent  banks,  will  obviously  be  five  times  as  large  as  the 
average  of  the  five,  and  its  efficiency  will  be  much  greater  than 
the  average  of  the  five.  But,  secondly,  the  combination  unit 
will  naturally  have  some  advantages  not  necessarily  belonging 
to  a  unit  of  equal  size,  derived  from  the  fact  that  it  is  the  result 
of  combination, — that  it  has  grown  out  of  a  variety  of  sources. 
Thus,  different  ones  of  the  combining  units  may  have  developed 
specially  efficient  methods  or  machines  which  are  more  or  less 
trade  secrets, — and  which  will  be  much  more  fully  utilized  after 
the  combination  has  been  made  than  before — under  an  equally 
large  unit  which  was  a  single  unit  from  the  outset,  these  would 
perhaps  never  have  been  developed. 

As  a  third  advantage  of  combinations,  it  is  always  possible 
that  the  formation  of  a  trust  will  establish  a  monopoly,  complete 
or  partial,  in  the  industry  involved.  That  is,  said  industry  is  liable 
to  be  brought  under  the  control  of  a  single  will,  natural  or  legal, 
which  is  what  we  mean  by  saying  that  a  monopoly  is  established. 
Now,  there  can  be  little  doubt  that  the  men  who  seek  to  get  a 
monopoly  in  any  given  case  desire  most  of  all  to  get  into  a 
position  where  they  can  regulate  price  in  such  a  way  as  to 
secure  the  largest  net  return  without  respect  to  cost.  But,  while 
this  doubtless  is  one  of  the  chief  hopes  of  monopoly  creators, 
there  is  also  ground  for  contending  that  monopoly  in  itself  tends 
at  some  points  to  increase  efficiency.  The  chief  argument  for 
this  is  that,  under  monopoly,  there  are  a  number  of  economies 
not  possible  to  free  competition,  (a)  Market  expenses  are 

83 


PRINCIPLES  OF  ECONOMICS 

smaller,  because  of  diminished  advertising,  smaller  number  of 
salesmen,  smaller  time  expense  of  selling,  and  so  on.  (b)  Trans- 
portation costs  are  smaller  because  orders  can  be  filled  from 
the  particular  plant  geographically  nearest  the  consumer,  (c) 
There  is  less  risk  of  loss  from  failing  to  calculate  correctly  the 
demand  in  that  a  monopolist  seeks  to  adjust  production  not  to 
his  possible  share  of  a  considerable  demand — a  quantity  which 
it  is  extremely  difficult  to  ascertain —  but  to  the  whole  demand, — 
a  quantity  comparatively  easy  to  approximate. 

We  have  seen  that  the  combining  of  independent  units  may 
contribute  to  efficiency.  But,  of  course,  this  is  not  the  whole 
story.  The  influence  of  combination,  particularly  when  it 
amounts  to  a  monopoly,  may  be  quite  unfavorable  to  efficiency 
(a)  First,  there  is  likely  to  be  less  stimulus  to  enterprise,  inven- 
tion, etc.  The  monopoly,  when  once  established,  tends  to  rest 
on  its  oars,  (b)  Secondly,  it  is  very  difficult  to  find  administra- 
tive officials  equal  to  the  duties  laid  upon  them  in  a  vast  business ; 
and  this  difficulty  is  greatly  enhanced  by  the  tendency  to  put 
into  such  places  persons  connected  by  family  ties  with  the  princi- 
pal owners  of  the  business,  without  much  regard  to  their  fitness 
for  the  places  in  question.  It  is  thus  evident  that  combination 
is  not  always,  or  in  every  respect,  favorable  even  to  productive 
efficiency.  Still  we  are  probably  justified  in  laying  down  the 
following 

Principle.  Generally  speaking,  mere  technical  efficiency  is 
usually  increased  by  the  consolidating  of  like  industries  under 
one  control 

Caution:  It  is  hardly  necessary  to  say  that  there  are  other 
aspects  of  the  trust  problem  besides  its  relation  to  mere  industrial 
efficiency.  In  so  far  as  the  existence  of  trusts  means  the  existence 
of  monopolies,  it  obviousy  limits  that  freedom  of  competition 
which  is  depended  upon  to  secure  a  right  regulation  of  our 
economic  activity.  Further,  that  same  element  of  monopoly 
gives  the  trust  undue  power  over  the  whole  industrial  field. 
Finally,  it  makes  possible  oppressively  high  prices.  All  these 
considerations  may  make  it  desirable,  even  necessary,  to  crush  out 
the  trust  altogether,  though  some  loss  in  efficiency  will  thereby 
result.  Anyhow,  there  can  be  no  doubt  that  it  will  be  necessary 
to  subject  such  institutions  to  a  large  degree  of  governmental 
control  for  the  protection  of  society  at  large. 

84 


CHAPTER  III.    PRODUCTIVE  EFFICIENCY 

Section  G.     Efficiency  in  Respect  to  the  Entrepreneur 
Function. 

The  preceding  discussion  of  productive  efficiency  has  set 
forth  the  more  general  principles  of  the  matter.  It  still  seems 
desirable  to  take  up  separately  the  particular  functions  involved 
in  production  and  ask  how  efficiency  is  best  secured  in  respect 
to  those  functions.  Here  we  begin  with  the  central,  principal, 
function, — assuming  the  responsibility  of  production. 

In  the  first  place,  we  need  to  distinguish  the  different  kinds 
of  entrepreneurs,  viz,  (a)  the  Individual  Entrepreneur  and  (b) 
the  Collective  Entrepreneur.  The  collective  class  give  us  three 
subdivisions:  (1)  the  Partnership,  (2)  the  Joint-stock  Associa- 
tion and  (3)  the  Corporation.  The  partnership  differs  from  the 
other  forms  of  collective  undertaking  in  that  its  unity  is 
unorganized,  or  anyhow  very  slightly  organized,  whereas 
both  the  joint-stock  company  and  the  corporation  are 
consciously  organized,  i.e.,  provided  with  officials  to  whom  are 
committed  the  different  necessary  functions,  and  in  some  of  whom 
is  placed  the  determining  will,  rather  than  in  the  members  taken 
individually.  While  the  joint-stock  company  and  the  corporation 
are  alike  in  being  organizations  they  differ,  or  at  least  earlier 
did  differ,  in  that  the  corporation  possesses  the  characteristic  of 
limited  liability;  i.e.,  the  members  of  a  corporation  are  respon- 
sible for  its  debts,  not  to  the  full  amount  of  their  property,  but 
only  to  a  strictly  defined  amount,  perhaps  just  what  they  have 
in  the  business  or  perhaps  that  and  as  much  more.  In  earlier 
times,  corporations  came  into  existence  only  by  a  special  act 
of  the  legislative  authority;  in  our  day  they  are  usually  formed 
by  administrative  process  under  the  authority  of  a  general  law. 
Taking  up,  now,  the  question  of  efficiency  with  respect  to  the 
entrepreneur  function,  we  note  first  that  there  are  three  chief 
requisites  of  such  efficiency:  (a)  an  adequate  volume  of  capital, 
(b)  enterprise,  initiative,  readiness  to  assume  the  responsibilities 
of  production,  and  (c)  judgment,  foresight  in  recognizing  good 
opportunities  for  undertakings.  The  third  of  these  requisites, 
wisdom,  foresight,  is  obviously  in  large  measure  a  matter  of 
endowment,  though  it  is  probable  that  education  and  the  general 
dissemination  of  knowledge  will  be  of  use  at  this  point.  Again, 
the  first  requisite,  an  adequate  volume  of  capital,  will  be  discussed 
in  the  next  section ;  since  the  supplying  of  that  capital  is  not  the 

85 


PRINCIPLES  OF  ECONOMICS 

peculiar  function  of  the  entrepreneur,  but  rather  of  the  persons 
whom  we  have  called  capitalists  par  excellence.  Accordingly,  in 
this  connection  we  confine  our  attention  to  the  second  requisite, 
readiness  of  people  to  take  the  initiative,—  assume  the  responsibility 
of  production.  This,  however,  requires  little  analysis  or  discus- 
sion, as  the  conditions  of  efficiency  at  this  point  are  fairly  obvi- 
ous. We  may,  therefore,  summarize  the  whole  matter  in  the 
following 

Principle.  High  productive  efficiency  in  respect  to  the  entre- 
preneur function,  in  so  far  as  it  is  not  a  matter  of  natural  en- 
dowment merely,  depends  chiefly  on  the  maintenance  of  condi- 
tions zvhich  (i)  minimize  the  individual  risk-burden  of  under- 
taking, (2)  make  possible  the  quick  and  easy  entry  into,  and 
withdrawal  from,  enterprises,  and  (3)  provide  or  permit  large 
profits  where  risk  is  unavoidably  great. 

ILLUSTRATIVE  PROBLEMS. 

1.  Something  less  than  a  century  back,  the  unlimited-liability 
partnership    form    of    cooperative    undertaking    was    much    the 
most   common.     Latterly,   limited-liability   organization    has    be- 
come very  general. 

Show  why  one  should  naturally  expect  this  change  to  con- 
tribute to  productive  efficiency,  especially  in  the  case  of  new 
enterprises.  Illustrate. 

2.  In  our  day  every  large  city  has  a  stock  exchange  where 
the  shares  of  great  corporations  are  daily  bought  and  sold. 

How  do  such  institutions  contribute  to  productive  efficiency? 

3.  Give  two  or  three  ways  in  which  patent  right  laws  con- 
tribute to  productive  efficiency. 

4.  There  is  much  to  be  said  in  condemnation  of  our  reck- 
lessness  in   permitting  private    individuals   to   exhaust   our   vast 
stores  of  natural  wealth  in  gold,  silver,  oil,  copper,  etc. 

What  can  be  said  on  the  other  side? 

5.  Was  there  any  excuse  for  the  great  liberality  displayed  in 
the  granting  of  trolley  car  franchises  in  the  late  eighties? 

6.  Argue  for  the  contention  that  a  much  more  efficient  pro- 
tection of  the  public  against  dishonest  promoters  of  mining  and 
other  enterprises   would   contribute  greatly   to  productive   effici- 
ency. 

Section  H.    Efficiency  in  Respect  to  the  Capitalistic  Function. 

It  has  already  been  repeatedly  emphasized  that  capital  is  a 

very  important  factor  in  production.     When  we  add  that  up  to 

86 


CHAPTER  III.    PRODUCTIVE  EFFICIENCY 

date  there  is  still  much  controversy  as  to  its  precise  nature,  how 
it  originates,  how  it  is  maintained,  and  so  on,  no  excuse  is  prob- 
ably needed  for  giving  it  a  fuller  treatment  than  will  be  accorded 
the  other  factors  in  production. 

A  very  little  reflection  will  make  clear  that  efficiency  on  the 
side  of  capital  involves  chiefly  three  things:  (1)  An  abundant 
stock,  (2)  availability,  and  (3)  wise  employment.  The  last  of 
these  depends  mostly  on  the  skill  and  capacity  of  the  entrepreneur 
who  determines  what  shall  be  produced  and  so  determines  to 
what  uses  capital  shall  be  put.  Accordingly,  we  are  here  con- 
cerned principally  with  the  conditions  on  which  we  depend  to 
secure  an  abundant  stock  of  capital  and  to  insure  that  that 
capital  shall  possess  a  high  degree  of  availability.  In  dealing 
with  the  question :  On  what  conditions  must  we  depend  for  se- 
curing an  abundant  stock  of  capital,  the  first  problem  which 
meets  us  concerns  the  origin  of  capital.  By  what  process  or 
processes  does  it  come  into  existence?  To  answer  this  question, 
therefore,  must  be  our  next  task. 

1.  How  Does  Capital  Come  Into  Existence? 
It  is  too  obvious  to  need  serious  argument  that  any  piece  of 
capital,  say  an  engine,  if  viewed  simply  as  a  physical  object,  has 
to  be  brought  into  existence  in  just  the  same  way  as  consump- 
tion products  have  to  be,  i.e.,  through  consciously  directed  labor 
assisted  by  land  and  capital.  Just  as  certain  factories  are  en- 
gaged in  making  hats,  golf  balls,  candy,  and  other  consumption 
goods,  so  certain  other  factories  are  engaged  in  making  engines, 
machines,  tools,  and  other  capital  goods.  At  first  sight,  then,  it 
might  seem  as  if  such  a  factory  was  the  place  to  study  the  ques- 
tion :  ''How  Does  Capital  Comie  into  Existence  ?"  In  fact,  how- 
ever, we  are  here  concerned  with  something  deeper  than  mere 
technical  production.  We  are  looking  for  the  ultimate  origin, 
the  moral  origin,  so  to  speak,  of  capital.  This  is  a  legitimate 
Question  to  ask  with  reference  to  any  product ;  for  under  an  ex- 
changing economic  order,  the  technical  producer  of  anything, 
whether  it  be  an  engine  or  a  pound  of  candy,  is  not,  in  the  most 
ultimate  sense,  responsible  for  its  existence.  He  produces  that 
engine  or  candy  because  he  knows  or  expects  that  other  people 
will  buy  it  from  him.  He  is  in  effect,  therefore,  acting  as  the 

87 


PRINCIPLES  OF  ECONOMICS 

agent  of  those  people.*  Now,  in  many  relations  this  way  of 
looking  at  the  matter  is  of  no  interest  to  us ;  but,  in  our  present 
connection,  it  is  very  important.  If  we  wish  to  know  the  ulti- 
mate origin  of  capital,  we  must  go  to  the  principal  rather  than 
the  agent.  Engines  and  other  forms  of  capital  are  things  the 
ownership  of  which  involves  keeping  large  amounts  of  value 
tied  up  all  the  time  while  getting  income — service — therefrom 
only  in  small  periodic  returns.  Not  everyone,  therefore,  is  in  a 
position  to  buy  and  own  such  goods.  How  does  the  actual 
buyer  get  himself  there  ?  In  this  case  the  actual  buyer  is  the 
entrepreneur,  who  very  likely  has  borrowed  the  money  to 
make  the  purchase.  Another  step  then  is  necessary.  How  did 
the  man  who  lent  the  money  to  the  borrowing  entrepreneur  get 
himself  in  a  position  to  do  this,  i.e.,  in  a  position  to  give  up,  say, 
$3,000  in  exchange  for  a  yearly  income  of  $150?  The  answer 

is  plain he  must  have  accumulated  a  money  fund  which  was 

to  him  for  a  longer  or  shorter  period  superfluous — i.e.,  could 
be  spared  from  other  possible  uses.  But  the  accumulation  of 
such  a  fund  obviously  requires  two  things:  (1)  he  must  get  the 
money,  must  from  some  source  derive  an  income,  and  (2)  he 
must  save  from  that  income,  must  practice  abstinence.  As  far  as 
the  first  condition  is  concerned,  this  must  presumably  be  fulfilled 
in  the  same  way  that  any  income  is  obtained,  i.e.,  he  himself  or 
his  property  must  supply  some  service  for  which  men  are  willing 
to  pay  a  price.  In  doing  this,  he  is  virtually  producing  in  the 
technical  sense  the  goods  capital  which  his  money  capital  later 
buys.  The  second  condition — saving — can  have  no  deeper  analy- 
sis. It  is  just  saving,  going  without  some  gratification  in  the 
present  which  would  otherwise  have  been  possible.  The  capi- 
talist has  a  certain  money  income ;  he  refrains  from  spending 
all  of  it  consumptively ;  as  a  consequence  he  has  a  fund  of 
money  with  which  he  himself,  or  someone  to  whom  he  lends  it, 
can  buy  engines  or  other  productive  goods.  As  economic  society 
is  at  present  conducted,  this  is  substantially  the  only  process  in 
which  capital  grows :  get  an  income;  save  from  that  income. 
But  to  say  that  one  saves  from  his  income  is  to  imply  the 
existence  of  that  income.  It  seems  sufficient,  therefore,  to  say 


*This   is   evident  enough   in   so   far 


83 


CHAPTER  III.    PRODUCTIVE  EFFICIENCY 

that  the  process  whereby  capital  is  accumulated  is  saving. 

Principle.  Under  the  existing  economic  order  capital  origi- 
nates chiefly  in  saving  or  abstinence. 

Comments:  (1)  In  insisting  that  capital  has  its  origin  in 
saving,  we  must  not  forget  what  was  said  at  the  beginning  of 
this  discussion,  that  any  concrete  piece  of  capital  has  to  be  pro- 
duced, on  its  technical  side,  just  as  is  any  other  piece  of  wealth. 
Under  our  system  of  specialization  the  technical  producing  of 
capital  is,  literally  speaking,  performed  by  someone  other  than 
the  capitalist;  but  it  surely  has  to  be  done.  For  some  purposes, 
it  is  very  important  to  fix  our  eyes  on  the  money  fund  which 
the  capitalist  is  accumulating  as  the  thing  to  be  recognized  as 
capital,  the  thing  to  be  followed  in  tracing  the  genesis  of  capi- 
tal. But  at  this  point  we  must  be  very  careful.  If  we  forget 
that,  along  with'  the  accumulation  of  money  funds,  there  must 
go  on  the  manufacturing  of  the  goods  capital  corresponding 
thereto,  we  are  likely  to  fall  into  serious  errors.  Both  these 
processes  must  be  carried  on  if  capital  is  to  exist.  Abstract 
or  money  or  formal  capital  must  be  accumulated,  and  concrete 
or  goods  capital  must  be  technically  produced.  In  dealing  with 
some  problems,  we  must  give  our  attention  to  money  capital, 
with  others  our  eyes  are  fixed  on  goods  capital.  But  capital 
building,  in  the  fullest  sense,  in  our  day  requires  that  both  be 
provided. 

(2).  In  the  above  discussion,  saving  is  put  forward  as  the 
true  source  of  capital.  Now,  this  word  saving  must  not  be 
understood  as  if  it  necessarily  involved  serious  deprivation. 
Often  this  is  not  the  case.  For  some  men,  spending  rather  than 
saving  would  bring  the  sacrifice.  But,  in  any  case,  the  relin- 
quishing of  the  right  to  spend  for  immediate  satisfactions  is 
necessary. 

(3).  The  antithesis  between  saving  and  spending  which  is 
involved  in  our  account  of  capital  building  needs  to  be  inter- 
preted with  some  care.  Spending,  as  thus  used,  does  not  in- 
clude every  case  of  exchanging  money  in  hand  for  some  com- 
modity or  service,  but  only  the  exchanging  of  such  money  for 
consumption  goods,  goods  of  which  we  do  not  expect  to  make 
any  other  use  than  the  direct  satisfying  of  wants.  Thus,  to 
part  with  money  in  exchange  for  an  engine  to  equip  a  factory 
would  not  be  spending  it  in  the  popular  sense  or  the  sense  here 
employed.  Instead,  such  a  use  of  money  would  be  described  as 
investing  it.  This  is  a  distinction  familiar  to  the  business 
world;  but  it  is  frequently  overlooked  and  so  becomes  the 
source  of  a  popular  fallacy  about  money. 

Corollary.  From  the  standpoint  of  people  in  general,  the 
rich  man  who  saves  from  his  income  is  to  be  commended  rather 

89 


PRINCIPLES  OF  ECONOMICS 

than  the  one  who  spends  it  on  himself  or  his  immediate  de- 
pendents. 

Let  the  student  give  the  argument.  (Why  may  we  expect 
that  the  increased  efficiency  will  benefit  people  in  general?) 

Meet  the  following  objections: 

(a)  If  the  rich  man  saves  his  money  instead  of  spending 
it,  there  will  be  just  so  much  less  demand  for  goods  in  general, 
hence  just  so  much  less  opportunity   for  employment. 

(b)  If  the  rich  man  saves  his  money,  instead  of  spending 
it,  the  consumption  goods  which  were  made  but  which  he  con- 
cluded not  to  buy  will  be   wasted  and  the   producer   of  those 
goods  will  be  injured. 

ILLUSTRATIVE  PROBLEMS. 

1.  Suppose  that   a  community  of  say  50,000   persons  living 
on  an  island,   completely  isolated   from   all   other   communities, 
but  otherwise  living  under  an  economic  system  like  ours  with 
division  of  labor,  trade,  metallic  money,  etc.,  should  attempt  to 
increase  its  capital  by  issuing  $100,000  of  paper  money. 

(a)  Argue  for  the  contention  that,  in  general,  we  should 
expect  this  attempt  to  fail. 

(b)  Try  to  find  some  reasons  for  thinking  that  the  scheme 
might  realize  a  small  measure  of  success.     (Would  said  scheme 
tend  to  increase  the  total  output  of  labor  services?     Would  it 
tend  to  release  any  labor  hitherto  devoted  to  the  old  tasks?) 

(c)  Change    the    hypothesis    by    supposing    the    given    com- 
munity to  be  in  free  trade  relations  with  many  other  communi- 
ties, and  argue  that  the  proposed  issue   would   really   increase 
the  capital  of  the  community. 

2.  "When  the  primitive  fisherman  refrains  from  eating  fish 
in  order  to  accumulate  a  store  to  be  eaten  while  he  makes  a 
net,   we   obviously  have   a   case   of    real   saving.     But   when    a 
capitalist  keeps  his   money  rather  than  spending  it,  things   are 
very   different.     The   good   things   our  capitalist  refrains    from 
consuming    have    not    been    made    at    all;     instead,    producers, 
knowing  that  capital  is  being  accumulated,  are  making  engines, 
cars,    etc.,    which    obviously    could    not   be    consumed.      But,    if 
they   could   not   be   consumed,   they   could   not   be    saved,    such 
capital,  therefore,   does  not  result   from  saving." 

Taking  as  your  definition  of  saving  this:  "Saving  is  going 
without  something  one  might  otherwise  enjoy,"  show  that  the 
capitalist  who  accumulates  a  fund  of  money  does  really  save. 

3.  Suppose   that,    instead   of  proceeding   as   at   present,   the 
capitalist  were  himself  to  make  the  concrete  pieces  of   capital, 
hoes,  plows,  planes,  engines,  etc.,  and  then  lend  these  to  pro- 
ducers for  hire.     Would  such  making  of  capital  involve  saving? 

90 


CHAPTER  III.    PRODUCTIVE  EFFICIENCY 

4.  Suppose  that  a  communistic  state,  in  order  to  increase  its 
stock  of  capital,  should  proceed  to  require  from  every  citizen 
one  more  hour  of  labor  daily.  Would  this  way  of  building 
capital  involve  saving? 

2.     Conditions  Favoring  the  Accumulation  of  Capital. 

We  have  seen  that,  under  present-day  conditions,  capital 
conies  into  existence  chiefly  through  saving,  abstinence — a  de- 
liberate relinquishment  of  the  present  disposal  of  income.  What 
conditions  favor  the  practice  of  this  line  of  conduct?  A  fairly 
adequate  general  answer  can  be  put  into  a  single  sentence. 

Principle.  The  accumulation  of  capital  is  favored  by  the 
existence  of  large  incomes,  by  conditions  which  insure  to  capi- 
talists the  expected  advantages  of  saving,  and  by  the  presence  of 
suitable  social  machinery  to  aid  in  caring  for,  and  investing, 
accumulations. 

ILLUSTRATIVE   PROBLEMS. 

1.  Give   reasons   for   expecting  capital  to   accumulate   more 
rapidly    in    England    than    in    Scotland;    in    Germany    than'    in 
Persia. 

2.  Suppose  the  total  income  of  industry  in  the  United  States 
were  divided  equally  among  all  the  citizens,  do  you  think  capi- 
tal would  grow  as  rapidly  as  it  now  does?     Why? 

3.  Explain  why  postal  savings  banks  would  be  expected  to 
increase  the  accumulation  of  capital ;   same  for  loan  and  trust 
companies;  same  for  insurance  companies. 

4.  From  our  present  standpoint,   argue   for   or  against  the 
Oklahoma  system  of  guaranteeing  bank  deposits. 

3.     Conditions  Favorable  to  Rendering  Capital    Available. 

It  hardly  need  be  said  that  mere  accumulation  of  capital  is 
not  enough;  if  it  is  to  do  its  part,  it  must  be  made  available. 
At  this  point  modern  business  methods  have  been  wonderfully 
successful.  We  are  able  to  utilize  not  only  the  more  considera- 
ble funds  which  people  have  definitely  set  apart  to  play  the 
role  of  capital,  but  also  a  great  amount  of  wealth1  which  is  only 
momentarily  idle  and  could  not  be  treated  as  capital  «at  all, 
were  it  not  for  modern  institutions  of  credit. 

Under  present-day  conditions,  capital  is  chiefly  utilized  by 
persons  other  than  those  who  accumulate  such  capital,  i.e., 
the  entrepreneur  is  a  different  person  from  the  capitalist  proper. 
Consequently,  availability  means  making  the  process  of  lending 

91 


PRINCIPLES  OF  ECONOMICS 

and  borrowing  easy.     Here,   as  under  the  preceding  head,  the 
general  conditions  can  be  put  in  a  sentence. 

Principle.  The  availability  of  capital  depends  on  a  high  state 
of  entrepreneur  credit  and  high  efficiency  in.  the  institutions 
which  deal  in  money  capital, — banks,  trust  companies,  and  so  on. 

ILLUSTRATIVE   PROBLEMS. 

1.  For    some    years    before    and    after    1892,    it    looked    to 
European  observers  as  if  the  United  States  were  likely  to  give 
up  the  gold  standard  and  adopt  silver,  thus  reducing  the  value  of 
the  dollar,  as   most  expected,  by  about   forty  per   cent.    What 
effect  would  you  expect  this  condition  to  have  on  foreign  cap- 
ital in  the  United  States? 

2.  The   existence   of  the  ordinary  commercial  bank  enables 
us  to  make  available  quantities  of  money  capital  out  of  funds 
which  are  not  really  set  aside  for  use  as  capital,  but  rather  are 
being  kept    for   daily   use.     Try   to  explain   how   that   can   be. 
(Suppose  that  500  persons  kept  the  funds  which  they  expect  to 
put  to  everyday  use  in  a  bank,  and  made  payments  partly  by 
cash    drawn    out,    partly    by    checks    drawn    in    favor    of    one 
another.     Show  that  the  bank  could  safely  treat  a  considerable 
part   of  the   funds   as   if  they   were   going   to    be   permanently 
idle.) 

3.  In  Germany  there  are  many  agricultural  loan  associations 
which  issue  jointly-guaranteed  bonds  to  the  lending  public,  then 
lend  to  their  members  on  ordinary  mortgage  security.     Does  it 
seem  likely  that  this  system  would  tend  to  make  capital  more 
available  to  farmers? 

Section  I.    The  Efficiency  of  Labor. 

(See  Reading  VIII.) 

It  is  a  matter  of  common  knowledge  that  there  are  great 
differences  between  different  countries  in  respect  to  the  effi- 
ciency of  labor.  The  causes  of  these  differences  are  in  part 
natural  and  so  in  the  main  irremovable.  Inherited  traits, 
physical,  mental,  moral,  must  keep  the  East  Indian  inferior  to 
the  English  or  American  laborer  for  many  generations  any- 
how. But  there  are  other  particulars  wherein  the  conditions 
of  labor  efficiency  are  more  or  less  controllable  through  legisla- 
tion or  individual  action.  In  part,  we  can  trust  the  natural 
working  of  self  interest  in  employers  and  laborers  to  secure 
these  conditions,  especially  as  the  diffusion  of  knowledge  makes 
evident  the  reality  of  these  conditions.  But,  in  not  a  few  par- 


CHAPTER  III.    PRODUCTIVE   EFFICIENCY 

ticulars,  it  has  proved  necessary  to  interfere  through  the  strong 
hand  of  the  state  to  protect  the  general  social  interest  in  highly 
efficient  labor,  from  suffering  at  the  hands  of  greedy,  short- 
sighted employers  and  laborers. 

The  most  important  conditions  of  high  labor  efficiency  are 
suggested  in  the  following  statement.  To  secure  high  labor 
efficiency,  we  need  (a)  material  conditions  fitted  to  insure  vigor 
of  body  and  mind,  (b)  political  and  social  conditions  which  con- 
tribute to  the  development  of  self-respect,  ambition,  and  so  on, 
and  (c)  some  system  of  remuneration  which  is  fitted  to  encour- 
age industry,  carefulness,  energy,  and  so  on. 

ILLUSTRATIVE   PROBLEMS. 

1.  It  is  often  said  that  the  Irishman  is  a  lazy  and  incapable 
laborer  at  home,  but  fairly,  even  highly,  efficient  in  America  or 
Australia.     Can  you  suggest  some  explanation  of  this? 

2.  Look    up    the    profit-sharing    system    (there    are    various 
books  on  the  subject — Oilman's  among  the  best),  and  argue  that 
it  is  likely  to  increase  the  efficiency  of  labor. 

3.  Compare  with  respect  to  probable  efficiency,  giving  reasons 
therefor:     the    slave    system,    the    time-wage    system,    and    the 
piece-wage    system. 

4.  Argue   for  and  against,  the  tendency   of  general   educa- 
tion to  increase  the  efficiency  of  manual  laborers. 

5.  Give  some  reasons  why  we  cannot  safely  leave  the  proper 
regulation  of  child  labor  to  free  contract.     (See  Reading  VIII; 
also  Mill,  Book  V,  Chapter  XI.) 


93 


CHAPTER  IV. 
COMBINING  PROPORTIONS  AND  PRODUCT. 

It  is  a  fact  too  evident  to  need  argument  that  substantially 
all  productive  processes  are  joint  processes, — processes  wherein 
two  or  more  factors  cooperate  in  accomplishing  the  result. 
Land  by  itself  can  produce  no  considerable  quantity  of  potatoes; 
labor  by  itself  can  produce  none;  a  furnace  can  not  give  out 
heat  without  coal;  feeding  the  coal  to  the  furnace  needs  labor; 
and  so  on. 

Again,  it  is  too  evident  to  need  argument  that  the  produc- 
tivity of  any  joint  or  cooperative  process  varies  more  or  less 
with  changes  in  the  combining  proportion.  Thus,  increasing  the 
quantity  of  labor  used  in  cultivating  a  certain  piece  of  land 
might  make  the  total  product  greater  or  might  leave  it  just  the 
same  or  might  even  make  it  smaller.  Further,  in  case  it  made 
the  product  greater,  the  increase  might  be  in  exact  proportion  to 
the  increase  in  labor  or  it  might  be  in  a  larger  or  smaller  pro- 
portion. Similar  statements  could  be  made  of  other  combinations 
of  factors,  say  a  locomotive  and  the  coal  used  in  firing  it.  If 
we  had  just  started  the  fire,  a  certain  increase  in  the  coal  fed 
might  increase  the  water  evaporated  much  more  rapidly  than  the 
increase  in  fuel  consumption.  At  a  later  stage,  there  might  be 
an  increase  in  water  evaporation,  but  one  which  was  less  than 
proportional  to  the  increase  in  fuel  consumption.  Still  later  the 
increase  in  fuel  consumption  might  bring  no  increase  in  evapora- 
tion ;  and,  finally,  might  even  diminish  it. 

Now,  in  the  main,  this  question  of  combining  proportions  is  a 
matter  of  industrial  technique  rather  than  of  economic  science. 
But  several  problems  which  it  suggests  are  of  the  utmost  im- 
portance in  strictly  economic  connections.  Thus,  the  ultimate 
'basis  of  a  community's  economic  capacity,  its  store  of  natural  re- 
sources,— the  land  it  controls, — is  definitely  limited  in  amount, 
whi.e  population  and  capital  can,  and  do,  increase ;  in  thus  in- 
creasing, they  alter  the  proportion  in  which  the  several  factors 
of  production  are  combined;  and  the  effect  of  this  in  changing 
the  rate  of  output  is  obviously  a  matter  of  great  moment.  Will 
the  additions  to  capital  and  labor  increase  product  ,it  all?  If  so. 

94 


CHAPTER  IV.    COMBINING  PROPORTIONS. 

will  the  increase  be  just  proportional  or  more  than  proportional 
or  less  than  proportional?  These  are  all  questions  \vhich  ob- 
viously have  a  marked  bearing  on  human  welfare.  It  is,  there- 
fore, very  important  that  we  get  a  clear  knowledge  of  the  more 
fundamental  principles  with  respect  to  the  effect  rpon  product 
of  changes  in  combining  proportions. 

Section  A.    Principles  Governing  the  Combining  of  Individ- 
ual Factors. 

The  more  important  problems  of  combining  ratios  arise  when 
we  bring  together  total  stocks  of  the  several  factors,  e.  g.,  the 
whole  land  outfit  of  England  over  against  its  outfit  of  capital  or 
labor  or  both.  But  we  must  find  our  fundamental  facts  in  the 
relations  between  particular  pieces  of  land,  of  capital,  and  of 
labor.  We  must  first  know  how  individual  units  of  land  and 
labor,  or  of  capital  and  labor,  or  of  land  and  capital,  behave 
when  combined  in  different  proportions.  To  rrake  she  problem 
as  simple  as  possible,  let  us  begin  with  a  series  of  hypothetical 
combinations  made  up  of  two  elements  each  of  which  is  divisible 
and  substantially  homogeneous,*  and  assume  that  certain  con- 
sequences will  follow  a  changing  of  the  combining  proportions. 
Having  obtained  from  these  hypothetical  experiments  definite 
notions  of  the  principles  and  relations  involved,  we  will  then 
show  that  actual  experience  confirms  our  assumptions. 

I.     Hypothetical   Combinations   with  Hypothetical  Results.     Two 
Factors,  Divisible  and  Homogeneous. 

1.     Factor   A  Constant.   Factor   B    Changing. 

a.     Three  Stages  :  Returns  Increasing;  More  than  Proportionately  ; 

Returns  Increasing  Less  than   Proportionately; 

Returns  Diminishing. 

Let  us  begin  by  representing  the  two  factors  which  we  are  to 
experiment  with  by  the  letters  A  and  B.  Let  us  suppose  our- 
selves to  start  with  a  large  amount  of  A  and  a  very  small  one 
of  B,  and  to  increase  the  amount  of  B  in  successive  experi- 
ments while  A  remains  constant.  Further,  let  us  assume  that 
the  results  of  our  experiments  are  as  follows:  (1)  During 
the  first  few  experiments,  output  increases  and  that  more 

*Such  a  case  might  be  roughly  realized  in  the  relations  of  a  piece  of 
Farm  land  substantially  uniform  in  respect  to  quality,  position,  etc.,  and  a 
quantity  of  labor  devoted  to  cultivating  said  land. 

93 


PRINCIPLES  OF  ECONOMICS 

rapidly  than  does  the  changing  factor,  B  ;  (2)  during  a  number  of 
experiments  next  following,  output  continues  to  increase  but 
less  rapidly  than  does  B;  (3)  during  the  remaining  experiments, 
output  actually  diminishes.  In  order  to  give  definiteness  and 
clearness  to  our  ideas,  these  imaginary  experiments  and  re- 
sults are  presented  in  numerical  form  in  Table  I.  The  fig- 
ures given  are  of  course  purely  imaginary,  as  are  the 
combining  elements,  A  and  B.  No  known  combination  could  be 
represented  in  just  this  way.  But  a  careful  study  of  some  such 
table  is  after  all  well-nigh  essential  to  a  clear  understanding  of 
the  real  cases. 

TABLE  I. 


I 

II 

III 

IV 

V 

VI 

VII 

VIII 

IX 

g 

H- 

.  * 

§ 

^ 

* 

"g  *» 

o*"5 

s 

g 

~&  ? 

"**   c? 

^ 

0  ^> 

O   **) 

-c^ 

•ex.  * 

S   v^ 

^-  "N 

^.  ^Q 

O>^3  ^S 

^*  ° 

s^ 

J^ 

"is 

£  § 

~§ 

^  S 

£>  £ 

{3  ^  M-~, 

^ 

6 

^ 

^•S 

XJM  •'J* 

^CL,  0 

i 

20 

2 

2 

.... 

.. 

.1 

I 

j 

2 

20 

3 

6 

I 

4 

•3 

2 

4 

3 

20 

4 

16 

2 

10 

.8 

4 

10 

4 

20 

$ 

35 

4 

19 

1.7 

7 

19 

5 

20 

6 

84 

7 

49 

4.2 

14 

49 

6 

2O 

7 

126 

14 

42 

6.3 

18 

42 

7 

2O 

8 

156 

18 

30 

7.8 

19.5 

30 

8 

20 

9 

179 

195 

23 

8.9 

19.8 

23 

9 

2O 

10 

200 

19.8 

21 

10 

20 

21 

10 

2O 

12 

236 

40 

36 

11.8 

19.7 

18 

11 

2O 

14 

266 

39 

30 

13-3 

19 

15 

12 

20 

16 

290 

38 

24 

14.5 

18.1 

12 

13 

2O 

18 

312 

36 

22 

15.6. 

17-3 

II 

14 

2O 

20 

330 

34 

18 

16.5 

16.5 

9 

15 

20 

22.2 

346 

36 

16 

17-3 

15-6 

7.2 

16 

20 

25 

362 

43 

16 

18.1 

14-5 

5-7 

17 

20 

28.5 

380 

50 

18 

IQ 

13-3 

5 

18 

20 

33-3 

393 

63 

13 

19.6 

11.8 

2.6 

19 

20 

40 

400 

78 

7 

2O 

10 

i 

20 

20 

44-4 

398 

44 

—   2 

19.9 

8.9 

—  5-5 

21 

20 

SO 

393 

—  5 

19.6 

7-8 

,    T 

22 

20 

57-1 

360 

56 

—  33 

18 

6.3 

—  4 

23 

20 

66.6 

280 

60 

—  80 

14 

4-2 

—  8 

24 

20 

So 

140 

56 

—  140 

7 

1-7 

—  5 

25 

20 

100 

80 

35 

—  60 

4 

.8 

—  3 

26 

20 

133-3 

40 

26 

—  40 

2 

•3 

t    T 

27 

2O 

200 

20 

20 

—  20 

I 

.1 

—  3-3 

90 


CHAPTER  IV.    COMBINING   PROPORTIONS 


In  this  table  the  first  column  shows  the  number  of  the  com- 
bination ;  the  second,  the  amount  of  As  in  the  combination ;  the 
third,  the  amount  of  Bs ;  the  fourth  gives  the  output  or  product 
for  each  combination ;  the  fifth  shows  what  the  increase  in  output 
would  be  if  it  were  proportional  to  the  increase  in  Bs;  while  the 
sixth  shows  the  actual  increase.*  Comparing  columns  V  and  VI, 
we  see  that  increases  in  output  are  more  than  proportional  up  to 
Combination  9;  less  than  proportional  from  9  to  19;  and  turn 
into  decreases  from  19  on.  That  is,  looked  at  from  one  point 
of  view  anyhow,  the  different  combinations  naturally  break  into 
three  stages  or  groups,  which  stages  may  be  characterized  as 
follows:  (i)  output  increasing  more  than  proportionately  or  at 
increasing  rate,  (2)  output  increasing  less  than  proportionately 
or  at  diminishing  rate,  (3)  output  diminishing. 

The  results  of  this  analysis  of  our  table  can  be  presented 
graphically  as  in  Diagram  I.  The  vertical  spaces  counting  from 

Diagram  /. 


2J  2£\23\34  *5  26 Z7 


\ 


*The  remaining  columns  will  be  explained  later. 

97 


PRINCIPLES  OF  ECONOMICS 

left  to  right  represent  the  successive  combinations.  The  diagram 
shows  a  series  of  dots  connected  by  a  continuous  line  and  another 
series  each  of  which  is  connected  to  some  member  of  the  first 
series  by  a  short  spur.  The  vertical  distance  of  any  dot  in  the 
continuous  line  above  the  preceding  dot  in  that  line  shows  the 
actual  increase  in  product.  The  vertical  distance  of  the  dot 
attached  by  the  spur  to  the  same  preceding  dot  from  said  pre- 
ceding dot  shows  what  would  have  been  a  proportionate  increase 
in  product.  It  will  be  noticed  that  up  to  combination  9,  all  the 
proportional  increase  dots  are  below  the  actual  increase  dots ; 
while  all  after  9  are  above.  Beyond  19  the  increases  are  turned 
into  decreases. 

Notes:  (1)  As  will  presently  appear,  the  combinations  which 
range  from  9  to  19  are,  for  divisible  factors,  the  only  practicable 
ones.  This  stage,  therefore,  is  in  such  cases  the  one  to  which 
we  have  most  frequent  occasion  to  refer.  Unfortunately,  con- 
ventional usage  designates  it  as  the  stage  of  diminishing  returns, 
and  we  can  scarcely  hope  to  reform  this  usage.  It  is,  however, 
of  great  importance  that  we  realize  that  this  is  not  a  stage  of 
diminishing  returns,  but  rather  one  of  returns  increasing,  but 
not  proportionately.  During  this  stage,  we  can  get  more  out 
of  our  stock  of  As  by  increasing  the  proportion  of  Bs;  but  not 
as  much  as  the  amount  of  Bs  added  might  lead  us  to  expect. 

(2)  In  conventional  phraseology,  Combination  9  is  calirsd  the 
point  of  diminishing  returns.  A  man  working  As  in  Combina- 
tion 12  would  be  described  as  working  them  beyond  the  point 
of  diminishing  returns. 

ILLUSTRATIVE  PROBLEMS. 

1.  If  you  had  10  As  and  8  Bs,  what  combination  would  you 
naturally  use?     What  one,  if  you  had  40  As  and  32  Bs?     If  you 
had  5  As  and  4  Bs?    60  As  and  75  Bs?     10  As  and  9  Bs?    5  As 
and  3  Bs?     10  As  and  7  Bs? 

2.  If  you  had  at  your  disposal  60  As  and  48  Bs,  how  much 
product  would   you   naturally  be   getting?     If   you  were  to   put 
in  6  more  Bs,  how  much  more  product  would  you  naturally  get? 
How  much  more,  if  you  added  another  6  Bs? 

3.  If  you  wished  to  get  the  utmost  possible  out  of  your  Bs, 
which  combination  would  you  choose?     Which  would   it  be,   if 
you  wished  to  get  tihe  utmost  possible  out  of  your  As? 

4.  (a)    Does   the    designation,    "the    stage   of   increasing   re- 
turns," suggest  to  your  mind  that  the  first  of  our  stages  is  the 
most  desirable  one  to  be  working  a  piece  of  land  in? 

(b)  Is  it? 

5.  "It  can  never  be  profitable  to  carry  the  utilization  of  any 
factor,  say  A  in  our  table,  beyond  the  point  of  diminishing  re- 
turns."    Refute  this  statement. 

98 


CHAPTER  IV.    COMBINING  PROPORTIONS 

6.  I  am  sometimes  disposed  to  call  the  stage  from  Combina- 
tion 9  to  19  the  stage  of  diminishing  efficiency.     Argue  for  the 
reasonableness  of  this  designation. 

7.  We  often  speak  of  cultivating  the  land  more  and  more 
intensively.     Suppose  A  in  our  table  to  be  land,  and  point  out 
what  combinations  would  involve  intensive  cultivation. 

8.  What    would    you    naturally    understand    the    expression, 
"lower  the  margin  of  cultivation,"  to  mean? 

b.     Alternative  Methods  of  Conceiving  the  Facts  Presented. 
(1)     Changes  Caused  in  Averages. 

In  the  foregoing  presentation  of  the  facts  brought  out  in  our 
table,  we  have  compared  the  actual  increase  in  output  as  factor 
B  has  increased  with  an  increase  which  would  have  been  pro- 
portional to  the  increase  in  B.  Another  quite  important  method 
of  presenting  these  same  facts  sets  forth  the  changes  which  fol- 
low the  successive  increases  in  B  in  respect  to  the  average  output 
measured  in  either  A  or  B.  The  figures  for  these  averages  are 
found  in  Columns  VII  and  VIII  of  our  table.  Since,  from  Com- 
bination 1  to  Combination  9,  the  total  output  is  increasing,  the 
average  per  unit  of  As  is,  of  course,  rising  during  that  stage. 
Further,  since  the  increase  is  more  than  proportional  to  the  in- 
crease in  Bs,  the  average  measured  in  Bs  will  also  rise.  That  is, 
the  first  stage  is  one  in  which  averages  increase  measured  in 
either  factor.  From  Combination  9  to  19,  the  total  still  increases 
and  so  the  average  measured  in  A  increases ;  but,  as  the  increase 
is  less  than  proportional  to  the  increase  of  B,  the  average  meas- 
ured in  B  is  diminishing.  That  is,  the  second  stage  is  one  in 
which  the  average,  measured  in  the  constant  factor,  increases, 
but,  measured  in  the  increasing  factor,  diminishes.  From  Com- 
bination 19  on,  since  the  total  falls  off,  the  average  diminishes 
measured  in  either  factor.  It  follows  that,  from  this  standpoint 
of  averages,  the  series  breaks  into  three  stages  as  before:  (1) 
both  averages  increasing,  (2)  averages  increasing-diminishing, 
and  (3)  both  averages  diminishing.  From  this  point  of  view,  it 
is  also  important  to  note  that  the  combinations  which  form 
boundaries  between  the  first  and  second  and  between  the  second 
and  third  stages,  viz.,  9  and  19,  are  maxima  combinations,  i.  e., 
in  9  the  total  return,  measured  in  B,  is  the  largest  possible,  while 
in  19  that  return,  measured  in  A,  is  the  largest  possible.  This 
supplies  a  possible  nomenclature  for  the  several  stages:  (1) 
ante-maxima,  (2)  inter-maxima,  and  (3)  post-maxima. 

99 


PRINCIPLES  OF  ECONOMICS 

These  facts  with  respect  to  averages  can  be  effectively  pre- 
sented by  graphic  methods.  In  the  accompanying  diagram,  the 
figures  at  the  top  show  the  number  of  the  combination,  the 
rectangles  included  between  the  base  line  X-X  and  the  continuous 
curve  represent  the  output  for  the  several  combinations  averaged 
for  a  unit  of  B,  while  the  rectangles  included  between  the  base 
and  the  dotted  curve  represent  the  output  averaged  for  a  unit  of 
A.  The  heavy  verticals  at  9  and  19  indicate  the  maxima  for  B 
and  A  respectively.  The  course  of  the  curves  shows  graphically 
how  the  output  measured  in  either  factor  increases  up  to  com- 
bination 9;  how  it  then  declines  when  measured  in  B,  but  i-till 
increases  as  measured  in  A  up  to  19;  and  how,  finally,  it  de- 
clines, as  measured  in  either  factor,  from  20  to  the  end. 

Diagram  ff. 


I     £ 


4\3    6    76     9  10  tl   tK  13  14  IS  16  17  IS  Iff  SO  ft  &  tt  S4  £3  S6  27 


N 


\ 


\ 


\ 


Note  :  The  preceding  analysis  suggests  that  we  may  properly- 
designate  Combination  9  as  the  one  of  maximum  efficiency  — 
from  the  standpoint  of  the  constant  factor  —  or  as  the  one  of 
maximum  returns  —  from  the  standpoint  of  the  changing  factor. 
So,  Combination  19  is  the  one  of  maximum  returns  for  the  con- 
stant factor  or  of  maximum  efficiency  for  the  changing  factor. 

The  facts  with  respect  to  averages  are  very  useful,  in  fact 
almost  necessary,  in  determining  the  comparative  advantages  of 
different  combinations.  Thus,  supposing  you  have  at  your  dis- 
posal 20  As  and  7  Bs,  —  the  figures  given  in  Combination  6,  — 
would  it  be  better  to  use  that  combination  or  some  other?  An- 
swer: It  would  be  better  to  discard  6  As,  thus  making  a  com- 
bination of  14  As  and  7  Bs,  i.  e.,  Combination  9.  For,  under 
Combination  6,  the  average  product,  measured  in  Bs,  is  only  18 
and,  so,  the  total  is  only  7  times  18  or  126;  while,  under  Com- 


100 


CHAPTER  IV.    COMBINING 

bination  9,  the  average  is  20  and,  so,  the  total  is  7  times  20,  or 
140. 

ILLUSTRATIVE  PROBLEMS. 

1.  If  you  had  at  your  disposal  60  As  and  24  Bs,  which  com- 
bination could  you  most  profitably  use?     Whidh  combination,  if 
you  had  24  As  and  60  Bs? 

2.  If  As  and  Bs  are  divisible  or  separable  factors,  production 
will  normally  be  confined  to  Combination  9  or   19  or  some  one 
lying  between  these.     Prove. 

3.  ''If  your   stocks   of   As   and   Bs   have   the   same   ratio   as 
Combination  9  or   19  or  any  one,  lying  between  these,  you  will 
find   it   most   profitable  to   use   just   the   combination   you   have; 
that   is,   under  the  conditions   named,   it   will   never   pay  you   to 
discard   any   of    your    stock    either    of    As    or    Bs."      Prove    this 
arithmetically  for  a  stock  of  10  As  and  7  Bs;   10  As  and  10  Bs ; 
20  As  and  25  Bs. 

4.  Suppose  that  you  have  been   using  40  As  and  32  Bs  in 
Combination  12  and  that  you  now  take  to  putting  in  4  more  Bs. 
How  many  units  of  product  will  eaclh  of  these  four  add?     How 
many  did  each  of  the  last  4  of  your  original  32  add? 

(2)   Changes  Caused  in  Marginal  Product  of  Changing  Factor. 

In  addition  to  the  preceding  methods  of  bringing  out  the 
facts  of  our  table,  there  is  still  another  which  must  not  be  over- 
looked. In  column  IX,  which  has  thus  far  been  disregarded,  we 
have  a  series  of  figures  which  indicate  what  is  commonly  known 
as  the  marginal  product  of  the  changing  factor,  B.  Thus  in  the 
second  combination  there  is  one  more  unit  of  B  than  in  the 
first,  while  there  are  four  more  units  of  product.  The  ninth 
column,  therefore,  has  for  this  combination  a  4, — the  amount 
which  the  last  or  marginal  unit  of  B  adds.  So,  in  the  third  com- 
bination, we  have  one  more  B,  while  product  is  ten  units  greater; 
the  last  column,  therefore,  shows  for  this  combination  a  10, — the 
amount  added  by  the  last  B.  Now,  if  we  compare  the  figures 
of  this  column  with  those  of  Column  VIII,  which  contains  the 
average  product  for  each  B, — As  being  ignored — we  see  that,  up 
to,  and  including,  Combination  9,  the  product  of  the  last  or  mar- 
ginal B  is  larger  than  the  average  product  for  Bs;  that,  from 
9  to  19,  the  marginal  product  for  Bs  is  smaller  than  the  average; 
and  that,  from  19  on,  it  is  less  than  zero.  Further,  and  this  is 
perhaps  most  important  of  all,  from  10  to  19,  each  marginal  pro- 
duct of  Bs  is  not  only  less  than  the  average,  it  is  also  less  than 
the  preceding  marginal  product, — in  other  words,  the  marginal 

101 


OF  ECONOMICS 

product  is  continually  declining.*  Now.  this  aspect  of  the  data 
supposed  to  be  derived  from  our  experiments  is  believed  to  be  of 
great  importance  because  of  its  relation  to  the  incomes  received 
by  laborers  and  other  contributors  to  production.  For,  ac- 
cording to  !he  most  widely  accepted  opinion,  each  contributor 
tends  to  get  the  amount  which  represents  the  addition  to  product 
made  by  the  marginal  member  -of  his  class.  So  that,  if  the  Bs 
in  our  table  represent  laborers  and  production  were  carried  for- 
ward to  Combination  13,  then  wages  would  tend  to  be  the  value 
of  the  ii  units  of  product  added  by  each  of  the  last  two  laborers. 
The  preceding  paragraph  gives  us  a  new  way  of  describing 
Combination  19.  Instead  of  calling  it  the  point  of  maximum  re- 
turns for  A,  we  may  call  it  the  point  of  minimum  marginal 
productivity  for  B.  That  is,  our  combination  contains  all  the 
Bs  it  will  stand.  Any  addition  to  the  proportion  of  that  factor 
will  reduce  rather  than  increase  product.  Its  marginal  productiv- 
ity in  the  next  combination  is  less  than  nothing. 

ILLUSTRATIVE  PROBLEMS. 

1.  It  is  believed  by  a  large  number  of  economists  that,  after 
the  stage  of  diminishing  returns  has  been  reached,  the  wages  of 
laborers  of  any  particular  class  will  tend   to  be  the  amount'  of 
product  which  the   marginal  laborer  of  their  class   adds  to  the 
total,  or,  briefly,  will  tend  to  be  their  marginal  product.    Accept- 

.  ing  this  doctrine  as  true,  and  supposing  that  our  A  represented 
land  and  our  B's  laborers,  and  we  were  dealing  with  a  small 
isolated  island  containing  20  units  of  land  and  12  laborers,  how 
many  units  of  product  would  each  laborer  tend  to  get?  How 
many,  if  there  were  13  laborers?  15?  17? 

2.  "When   the   stock   of  capital   was   so   small   that   only  the 
most  necessary  instruments  of  production,  e.g.,  nets,  plows,  oxen, 
could  be  had,  the  marginal  productivity  of  capital  was  very  high. 
But,  as  savings  increased  so  that  almost  every  improvement  men 
had  thought  of  could  be  introduced,  the  marginal  productivity  of 
capital    raprdly    fell.      However,    discovery    and    invention    came 
along   and    again    sent    up    marginal    productivity;    though   here, 
again,  the  higher  efficiency  of  industry,  by  increasing  income,  led 
to  increased  saving, and,  so,  again  reversed  the  movement/' 

(a)  Explain  what  is  meant  by  the  marginal  productivity  of 
capital. 

(b)  Argue  for  the  truth  of  the  first  two  sentences. 

(c)  Argue  in  favor  of  both  clauses  of  the  third  sentence. 

(d)  Argue  for  the  proposition  that  it  is  natural  to  suppose 

*  It  began  to  decline  as  early  as  Combination  6.  But  it  was  still  above 
the  average  down  to  Combination  10;  and  its  falling  off  is  of  importance 
only  after  it  has  become  smaller  than  the  average. 

102 


CHAPTER  IV.    COMBINING  PROPORTIONS 

that  the  rate  of  interest  moved  down  or  up  as  the  marginal  pro- 
ductivity of  capital  moved  down  or  up. 

3.  Suppose  that  producers  are  using  Combination  12;  that 
the  price  of  the  product  is  $50  per  hundred ;  and  that  the  stock 
of  As  can  not  be  increased. 

(a)  Assuming  that  the  price  of  the  changing  factor  tends  to 
be  equal  to  the  money  value  of  its  marginal  product,  what  would 
naturally  be  the  price  of  Bs  under  the  above  hypothesis  ?  Answer : 
$6.    Prove. 

(b)  Assuming  that  the  money  value  of  the  total  amount  of 
As  used  in  the  combination  tends  to  equal  the  value  of  the  total 
product  minus  what  has  to  be  paid  for  the  Bs,  what  would  natur- 
ally be  the  price  of  As  under  our  hypothesis? 

"(c)  Suppose  that  the  supply  of  Bs  pressing  for  sale  at  what- 
ever price  they  will  bring  should  be  so  increased  that  production 
was  carried  far  down  into  Combination  14.  With  the  price  of 
the  product  at  $55-55  per  hundred,  what  would  be,  the  natural 
price  of  Bs? 

(d)  What  would  be  the  natural  price  of  As,  under  the  last 
hypothesis? 

c.    Changing  Combinations  and  Costs. 

Growing  out  of  the  data  which  have  been  presented  with 
respect  to  the  influence  on  product  of  changes  in  combining 
proportions,  are  certain  important  facts  with  respect  to  the  rela- 
tion between  costs  and  combining  proportions,  as  also  between 
costs  and  the  volume  of  output.  If,  in  producing  the  commodity 
which  is  supposed  to  result  from  the  union  of  As  and  Bs,  we 
could  get  our  As  without  cost  but  were  obliged  to  pay  for  Bs, 
then  the  relations  between  combining  proportions  and  costs  would 
be  grouped  in  stages  substantially  the  same  as  those  which  we 
have  already  met.  So  long  as  output  was  increasing  more  than 
proportionately,  cost  would  be  declining.  When  output  increased 
less  than  proportionately  or  ceased  to  increase  at  all,  costs  would 
increase.  In  other  words,  from  Combination  i  to  Combination  9 
we  should  have  a  stage  of  diminishing  cost,  and  from  10  on  a 
stage  of  increasing  cost.  But,  in  the  real  world,  it  usually  proves 
true  that  As  have  a  cost  as  well  as  Bs.  In  consequence,  the  com- 
bination showing  least  cost  inevitably  comes  later  than  9.  For, 
since  the  output,  as  measured  in  As,  continues  to  increase  up  to 
Combination  19,  total  cost  as  influenced  by  As  continues  to  di- 
minish up  to  that  point.  In  other  words,  between  Combinations 
9  and  19,  costs  are,  tending  to  increase  under  the  influence  of  B 
and  to  diminish  under  the  influence  of  A.  In  consequence,  the 
stage  of  minimum  cost  is  bound  to  lie  somewhere  between  9  and 

103 


PRINCIPLES  OF  ECONOMICS 

ig,  depending  on  the  relative  magnitude  of  the  cost  of  As  and  Bs. 
Thus,  if  As  cost  $i  each  while  Bs  cost  $2  each,  the  lowest  total 
cost  will  be  reached  in  Combination  13.  If  As  cost  $2  each  and 
Bs  $i,  the  lowest  total  cost  will  be  found  under  Combination  16. 
Accordingly,  we  have  the  general  principle  that,  if  one  of  the 
factors  in  a  combination  be  increased  steadily  while  the  other 
remains  constant,  there  will  be  a  series  of  combinations  under 
which  cost  steadily  declines  followed  by  one  in  which  cost  steadily 
increases.  It  results,  of  course,  that  the  aim  of  every  responsible 
producer  will  be  to  find  and  use  that  particular  combination 
which  shows  the  lowest  total  cost. 

ILLUSTRATIVE  PROBLEMS. 

1.  (a)     If  you  had  to  pay  $2  each   for  As  and  $5   for   Bs, 
which   combination   would    you   find    it   most    profitable   to    use? 
(Look  for  the  combination  which  will  give  you  the  smallest  cost 
per  unit.) 

(b)   Reverse  the  prices  and  answer  the  question. 

2.  Suppose  that  you  already  had  on  hand  20  As  and  wished  to 
utilize  them  as  profitably  as  possible. 

(a)  With  Bs  costing  you  $7-5o  each  and  product  selling  at 
$50  per  hundred,  which  combination  would  you  find  most  profit- 
able?    Answer:    Combination  n.     Prove.     (You  would  add  Bs 
until  the  value  of  the  increase  in  product  became  too  small  to 
pay  for  the  added  Bs. ) 

(b)  Which  combination,  if  Bs  were  costing  you  $6  each  and 
product  were  selling  at  $66.66^3  per  hundred? 

2.  Factor  B  Constant,  Factor  A  Changing. 
In  the  preceding  series  of  experiments,  A  was  supposed  to 
remain  constant  while  B  increased.  If,  now,  we  were  to  reverse 
the  hypothesis,  keeping  B  constant  and  increasing  A,  what  re- 
sults would  we  have?  Precisely  similar  ones  to  those  already 
brought  out,  with  the  places  of  A  and  B  reversed.  That  is,  for 
a  time  output  would  increase  more  than  proportionately  to  the 
increase  in  A,  then  would  increase  less  than  proportionately,  and 
finally  would  diminish.  And  this  is  not  a  new  principle  based 
upon  a  new  induction.  On  the  contrary,  a  table  reversing  the 
relations  of  A  and  B  both  as  to  conditions  and  results  is  directly 
deducible  from  the  table  already  given.*  From  this  fact  it  follows 
that,  if  the  principles  already  'hypothetically  brought  out  prove  to 
be  true  in  fact  for  a  combination  in  which  one  factor,  say 

*  In  an  appendix  is  to  be  found  such  a  table  together  with  the  processes 
by  which  it  is  derived  from  Table  I. 

104 


CHAPTER  IV.    COMBINING   PROPORTIONS 

capital,  is  constant,  while  the  other,  say  labor,  is  increasing,  then 
similar  principles  must  be  true  of  combinations  in  which  the 
second  factor,  labor,  is  constant  and  the  first  factor,  capital,  is 
increasing. 

II.     Actual  Combinations. 

1.     Both   Factors   Divisible. 

a.     Statement  of  Facts. 

In  the  preceding  discussion  we  have  been  concerned  with 
imaginary  results  of  imaginary  changes  in  the  combining  pro- 
portions of  imaginary  factors.  We  must  now  ask  whether  these 
results  correspond  in  a  general  way  with  those  which  we  should 
meet  in  actual  life.  The  answer  is,  of  course,  affirmative.  If, 
for  example,  one  were  to  take  a  ten-acre  field  devoted  to  raising 
potatoes  and  in  successive  seasons  spend  in  cultivating  it,  say, 
1  day's  labor,  then  5  days',  then  10,  then  40,  then  80,  and  so  on, 
he  would  doubtless  meet  results  analogous  to  those  presented  in 
our  tables.  That  is.  during  a  few  experiments,  the  product  would 
increase  and  that  more  rapidly  than  the  labor;  then,  for  a  con- 
siderable number,  the  product  would  increase,  but  less  rapidly; 
finally,  product  would  diminish.  Do  these  statements  need  dem- 
onstration? As  to  the  existence  of  the  third  stage,  there  surely 
could  be  no  doubt :  it  certainly  is  possible  to  put  too  much  work 
on  a  given  crop,  to  cultivate  it  too  many  times.  Again,  there 
can  be  no  doubt  as  to  the  existence  of  the  first  stage.  One  day's 
hoeing  put  on  a  ten-acre  lot  during  the  whole  season  would 
probably  not  produce  an  appreciable  result.  Anyhow,  5  days 
put  on  the  same  lot  would  increase  the  crop  much  more  than 
five  times  as  much  as  did  the  one  day  of  hoeing.  Further,  there 
can  be  no  doubt  that  ten  days'  hoeing  would  increase  the  crop 
more  than  twice  as  much  as  the  five  days  did.  That  is,  a  stage 
short  or  long  during  which  product  increases  more  rapidly  than 
labor,  is  assured.  The  only  question  remaining,  then,  concerns 
the  second  stage.  Conceivably,  the  stage  of  more  than  propor- 
tionate increase  might  continue  till  that  of  actual  falling-off  came 
on.  Is  there  in  fact  a  transitional  one  during  which  product 
still  increases  but  does  so  less  than  proportionally? 

It  seems  easy  to  establish  the  affirmative  by  two  considera- 
tions ; — it  being  assumed  that  the  practices  of  actual  farmers 
may  be  trusted  to  furnish  a  clue  to  the  more  general  principles 

105 


PRINCIPLES  OF  ECONOMICS 

of  industrial  technique.  First,  everywhere  we  find  under  cultiva- 
tion lands  inferior,  as  respects  productivity,  to  the  very  best. 
From  this  it  must  be  concluded  that  the  cultivation  of 
the  best  lands  has  anyhow  passed  through  the  first  stage; 
since,  otherwise,  the  farmers  would  work  those  best  lands 
harder  rather  than  put  their  labor  on  inferior  lands.  Secondly, 
we  find  everywhere  that,  when  different  grades  of  land  are 
already  under  cultivation,  and,  so,  the  best  1and,  anyhow,  has 
passed  through  the  first  stage,  a  rise  in  the  price  of  products 
leads  farmers  to  put  more  labor  on  those  best  lands,  or,  in 
ordinary  language,  to  cultivate  them  more  intensively ; — a  thing 
which  they  surely  would  not  do  if  nothing  were  to  be  gained  by 
it.  It  follows,  then,  that  land-labor  combinations  frequently  are 
in  the  second  stage,  i.  e.,  the  stage  of  output  increasable  less  than 
proportionately.  Of  course,  then,  that  stage  is  a  possible  one 
for  such  combinations. 

From  the  preceding  paragraph  we  learn  that,  if  we  keep  the 
land  elements  constant  in  land-labor  combinations  while  increas- 
ing the  labor  element  the  combinations  would  show  three  stages : 
(1)  product  increasing  more  than  proportionately  to  labor,  (2) 
product  increasing-  less  than  proportionately  to  labor,  and  (3) 
product  decreasing.  But,  as  was  shown  in  our  discussion  of 
imaginary  combinations,  if  the  above  is  true  of  a  series  of  ex- 
periments wherein  land  remains  constant  while  labor  increases, 
it  is  of  necessity  equally  true  of  a  series  wherein  labor  remains 
constant  while  land  increases.  That  is,  if  1,000  days'  labor  per 
year  were  put,  first  on  one  acre,  then  on  two,  then  on  three,  and 
so  on,  the  combinations  would  show  three  stages:  (1)  product 
increasing  more  than  proportionately  to  land,  (2)  product  in- 
creasing less  than  proportionately  to  land,  and  (3)  product  de- 
creasing. 

In  the  foregoing  attempt  to  show  that  the  results  of  our 
imaginary  combination  correspond  to  actual  experience,  we  have 
considered  only  land-labor  combinations.  But  there  is  little  need 
of  argument  to  convince  any  one  that  similar  principles  prevail, 
in  some  degree  anyhow,  in  the  case  of  land-capital  combinations. 
Thus,  if  our  experiment  had  been  to  try  the  effect  in  successive 
seasons  of  ever-increasing  quantities  of  fertilizer,  we  should 
doubtless  have  met  with  results  substantially  the  same  as  those 
heretofore  presented.  For  the  first  few  seasons,  product  would 
have  increased  more  rapidly  than  the  fertilizer  consumed ;  later, 

106 


CHAPTER  IV.     COMBINING  PROPORTIONS 

product  would  have  increased  less  rapidly;  finally,  it  would  have 
declined.  Perhaps  the  second  stage  would  have  been  briefer 
than  in  the  case  of  the  land-labor  combinations ;  i.  e.,  the  advan- 
tage of  increasing  the  fertilizer  used  would  have  been  exhausted 
sooner  than  the  advantage  of  increasing  the  cultivation.  But  the 
general  course  of  results  would  have  been  the  same. 

In  the  preceding  discussion,  we  were  considering  the  case  of 
combinations  between  land,  on  the  one  hand,  and  labor  or  capital 
or  both,  on  the  other.  But  we  hardly  need  say  that,  if  we  were 
to  consider  combinations  wherein  the  place  of  land  was  taken  by 
a  producible  instrument  like  an  engine  or  a  power  plant,  we 
should  have  similar  phenomena.  Thus,  if  we  suppose  a  power 
plant  planned  to  supply  ordinarily  100  horse  power,  to  be  fed  in 
successive  experiments  200  pounds  of  coal,  then  240,  then  280, 
and  so  on,  we  should  find  our  plant  passing  through  the  same 
three  stages  so  often  described.  Still,  again,  if  we  were  to  take 
in  place  of  land  a  pair  of  draft  horses,  and  make  a  series  of  ex- 
periments to  ascertain  the  relation  of  their  work  output  to  the 
food  supplied  them,  increasing  the  amount  of  such  food  in  each 
successive  experiment,  we  should  meet  results  exactly  analogous 
to  those  already  worked  out  in  the  other  cases.  In  short,  we 
may  be  sure  that  we  have  here  a  general  law  for  the  behavior 
of  combining  factors  under  all  possible  combining  proportions. 
Since  familiarity  with  the  results  of  possible  combinations  is 
needed  for  a  clear  comprehension  of  the  whole  matter,  let  us 
summarize  this  discussion  in  a  formal  principle. 

b.     Formulation  of  Principles. 
(1)     General  Law  of  Possibilities. 

Principle.  Supposing  that  the  attempt  be  made  in  successive 
production  periods  to  increase  the  output  (product)  from  any 
instrument  of  production  by  increasing  the  expenditure  of  assist- 
ing factors  in  connection  with  said  instrument  from  zero  up- 
wards, then,  as  respects  the  ratio  of  output  (product)  to  expendi- 
ture for  assisting  factors,  said  instrument  will  sooner  or  later  be 
found  in  each  of  the  following  stages,  vis.: 

(7)  Output    increasing    more    than    proportionately    (at    in 
creasing  rate}; 

(2}  Output  increasing  less  than  proportionately   (at  dimin- 
ishing rate} ; 

(j)   Output  decreasing. 

107 


PRINCIPLES  OF  ECONOMICS 

Note :  The  output  or  product  here  had  in  mind  is  goods 
output,  not  money  output.  The  problem  in  hand  is  primarily 
one  of  industrial  technique,  not  of  business  finance.  We  are  not 
asking  whether  the  producer  will  make  smaller  or  larger  profits 
by  choosing  one  combination  rather  than  another,  but  whether 
he  will  get  a  smaller  or  a  larger  physical  product.  There  is  no 
harm  in  expressing  the  varying  expenditure  in  money;  but  the 
output,  or  product  must  be  in  the  shape  of  goods. 

(2)     Divisible  Factors  Normally  Used  in  Second  Stage. 

The  preceding  discussion  has  brought  out  the  different  stages 
in  which  a  productive  combination  of  two  factors  would  one 
time  or  another  be  found,  provided  all  possible  combining  pro- 
portions were  tried.  As  already  remarked,  this  study  of  possi- 
bilities is  needed  for  a  clear  comprehension  of  the  whole  matter. 
It  is  also  needed  to  prepare  the  way  for  some  special  cases  to  be 
considered  later.  But  we  hardly  need  say  that  not  all  of  the 
possibilities  considered  have  practical  significance.  If,  for  ex- 
ample, our  combining  elements  were  land  and  labor,  the  first, 
and  last  of  the  three  stages  we  have  been  considering  could 
never  be  realized  in  industrial  practice,  save  by  accident  or  error. 
Thus,  the  last  would  be  shut  out,  since  no  one  would  be  foolish 
enough  to  continue  to  increase  the  amount  of  labor  spent  on  a 
piece  of  ground  after  the  output,  whether  measured  in  the  land 
or  in  the  labor,  was  diminishing.  So,  the  first  stage  would  be 
excluded,  since  any  of  its  combinations  would  give  a  smaller 
return,  whether  measured  in  land  or  in  labor,  than  the  first 
maximum  combination — number  9  in  our  original  table ; — and 
any  of  these  inferior  combinations  could  be  changed  into  the 
first  maximum  by  simply  letting  some  of  the  land  lie  idle.  Ac- 
cordingly, under  normal  conditions,  a  piece  of  land  would  be 
worked  in  one  or  another  of  the  combinations  ranging  from  the 
labor  maximum  to  the  land  maximum. 

But,  again,  in  representing  the  practical  combinations  as 
ranging  from  the  labor  maximum  to  the  land  maximum,  we  are 
still  recognizing  a  wider  range  than  the  facts  will  usually  war- 
rant. In  the  real  world,  the  land  is  probably  never  cultivated  to 
the  point  of  maximum  capacity  or  returns;  while,  on  the  other 
hand,  in  older  countries,  anyhow,  most  of  it  is  probably  culti- 
vated beyond  the  stage  of  maximum  efficiency.  Generally  speak- 
ing, it  would  pay  to  hold  back  the  cultivation  of  land  at  Com- 
bination 9  only  when  land  could  be  had  in.  unlimited  amount 
without  cost;  so  it  would  pay  to  drive  the  working  of.  the  land 

108 


CHAPTER  IV.    COMBINING  PROPORTIONS 

as  far  as  Combination  19  only  when  labor  could  be  had  in  un- 
limited amount  without  cost.  Accordingly,  the  combinations  in 
actual  use  are  usually  to  be  found  among  those  which  we  have 
called  inter-maxima,  i.  e.,  10  to  18  in  our  original  table.*  Put- 
ting this  into  formal  shape,  we  have  the  following 

Principle.  Barring  accident  and  error,  divisible,  factors  as- 
sisted by  divisible  factors  will  normally  be  found  in  some  of  the 
combinations  which  range  from  that  of  maximum  efficiency  to 
that  of  maximum  returns,  i.  e.,  in  the  stage  of  diminishing  re- 
turns or  diminishing  efficiency. 

(3)     Conventional  Law  of  Diminishing  Returns. 

To  bring  our  discussion  into  closer  accord  with  conventional 
methods  of  treating  the  matter  before  us,  I  will  formally  set 
forth  what  is  an  obvious  corollary  from  the  general  principle 
laid  down  on  page  107,  viz.,  the  point  that,  if  we  try  to  increase 
indefinitely  the  product  from  any  given  instrument  of  production, 
said  instrument  will  some  time  or  other  get  into  the  stage  of 
diminishing  returns  or  diminishing  efficiency.  The  following  will 
answer  as  a  formal  statement: 

Principle.     The  Instrumental  Law  of  Diminishing  Returns. 

In  the  process  of  attempting  to  utilize  more  completely  any 
productive  instrument  by  increasing  the  amount  of  the  assisting 
factors  combined  with  it,  in  other  words,  by  expending  more 
upon  it,  there  comes  a  stage  during  which  output,  though  con- 
tinuing to  increase,  does  so  mere  slowly  than  the  assisting  factors 
are  increased, — it  being  assumed  that  all  other  conditions  are 
unchanged,  there  being  no  improvement  in  technical  methods,  no 
deterioration  in  the  instrument,  and  so  on. 

(4)  The  Law  of  Diminishing  Productivity. 
The  foregoing  principle  has  brought  out  the  chief  point  in- 
volved from  the  standpoint  of  the  constant  factor.  As  we  saw 
earlier,  substantially  the  same  point  can  also  be  expressed  from 
the  standpoint  of  the  changing  factor.  As  we  most  usually  con- 
ceive the  matter,  the  constant  factor  gives  off  a  larger  output  but 
not  one  as  much  larger  as  is  the  expenditure  of  the  changing 
factor.  But,  in  one  very  important  connection,  we  are  following  the 
changing  factor  and  conceiving  it  as  making  smaller  and  smaller 

*I  hardly  need  say  that  a  table  corresponding  to  the  facts  of  land  culture 
would  be  no  such  simple  or  symmetrical  one  as  that  which  we  have  used. 

109 


PRINCIPLES  OF  ECONOMICS 

additions  to  output.  From  this  viewpoint,  we  have  the  Instru- 
mental Law  of  Diminishing  Productivity. 

Principle.     The  Instrumental  Law  of  Diminishing  Productivity. 

Under  normal  conditions,  the  marginal  productivity  of  either 
factor  in  a  divisible  factor  combination  tends  to  vary  inversely 
as  its  quantity. 

2.     One   Factor    Indivisible. 

Thus  far  in  our  analysis  we  have  assumed  that  our  combin- 
ing factors,  A  and  B,  are  divisible; — that  we  could  cut  down  at 
will  the  amount  of  A  or  B — of  land  or  labor — used.  If  we  had 
20  As  and  8  Bs — Combination  7  in  our  first  table — we  could 
choose  the  superior  combination,  No.  9,  by  simply  throwing 
aside  4  of  our  As.  But  this  assumption,  that  any  and  every 
factor  is  perfectly  divisible,  is  obviously  too  sweeping.  Many 
things  are;  but  many  others  are  not.  Thus,  a  furnace  for  heat- 
ing the  house,  a  plant  for  supplying  power,  a  draft  animal, — none 
of  these  can  be  divided,  and,  so,  with  none  of  them  can  the 
amount  used  be  arbitrarily  cut  down.  Does  this  fact  alter  the 
principles  governing  these  cases?  No  and  yes.  As  respects 
possibilities,  this  new  case  is  substantially  the  same  as  that  which 

TABLE  III 


I        II 

III 

IV 

V 

VI 

VII 

No.  of  Amount  Amount 
Combl-  of  Power    Coal, 
nation       Plant       Ibs. 

Output 
horse 

power 

Propor- 
tional 
Increase 

Actual 
In- 
crease 

Average 
per  lb.. 
coal 

2 

») 

4 

5 

200 
240 
280 
320 
360 

30 

48 
64 
77 
89 

6." 
8. 
9-i 
9-6 

"18 
16 
13 

12 

.15 

.2 
.228 
.242 
.248 

6 

4OO 

100 

9.9 

IO 

•25 

8 
9 

10 

ii 

[ 

[ 

440 
480 

520 

560 
600 

108 
114 

118 

121 
123 

10 
9.8 
9-5 
9- 
8.6 

8 
6 
4 
3 

2 

.245 
.237 
.226 
.216 

.2 

12                 I 

640 

124 

8.2 

I 

•  193 

13             I 

14         I 

680 
720 

123 
110 

77 
7.2 

Hi38 

.18 
.154 

110 


CHAPTER  IV.    COMBINING  PROPORTIONS 

we  have  considered.  A  furnace,  a  power  plant,  a  draft  horse, 
over  aganst  the  fuel  or  food  necessary  to  get  work  from  it,  will 
show  the  same  three  stages  and  the  same  two  turning  points 
which  we  have  already  met.  Thus,  if  we  suppose  ourselves  to 
have  control  of  a  100  horse-power  power  plant,  consisting  of  a 
single  unit,  and  to  make  with  it  a  series  of  experiments  by  which 
the  coal  fed  to  the  furnace  should  increase  in  successive  experi- 
ments from  200  pounds  to  640,  there  can  be  no  doubt  that  we 
should  have  results  substantially  as  represented  in  the  following 
table.  Here  the  return  per  power  plant  and  per  pound  of  coal 
increases  up  to  Combination  6 ;  from  there  to  Combination  12, 
the  return  per  plant  continues  to  increase  but  that  per  pound  of 
coal  declines;  from  12  on,  the  return  per  plant  or  per  pound  of 
coal  declines. 

We  have  seen  that  this  case  of  an  indivisible  factor  gives  us 
the  same  three-stage  principle  which  we  had  before,  provided  we 
are  considering  possibilities.  When,  however,  we  ask  as  to 
actual,  practicable,  combinations,  the  answer  ?hows  some  note- 
worthy differences  from  the  case  of  divisible  factors.  In  the 
first  place,  the  practical  combinations  are  not  limited  to  the 
second  stage.  Those  of  the  third  stage,  indeed,  are  shut  out: — 
no  one  will  knowingly  feed  additional  coal  to  a  power  plant 
after  this  begins  to  cause  a  diminution  in  the  power  supplied. 
But,  while  the  third  stage  is  excluded,  the  first  is  not.  Third- 
stage  combinations  are  shut  out  because  a  better  alternative  is 
always  open; — a  producer  can  always  withhold  the  excess  of 
coal  and  make  his  total  higher.  At  this  point  he  would  better 
give  the  coal  away  than  to  feed  it  to  his  furnace.  When,  how- 
ever, we  are  considering  first-stage  combinations,  She  case  is 
different.  Since  a  single-unit  power  plant  is  not  divisible;  it 
must  be  used  as  a  whole  or  not  at  all.  Consequently,  when  the 
need  falls  off,  when  we  want  less  than  the  maximum  power  per 
coal  unit,  we  can  not  maintain  the  best  combination,  No.  G,  by 
simply  leaving  a  part  of  the  plant  unused.  Instead,  we  have  to 
run  the  whole  outfit  at  a  lower  stage  of  efficiency.*  It  follows, 
then,  that,  in  an  entirely  reasonable  handling  of  indivisible 
instruments  of  production,  they  will  be  used  in  the  first  or  ante- 
maxima  stage, — the  stage  in  which  the  total  output  is  smaller 

*This  suggests  one  of  the  advantages  of  large-scale  production.  If  we 
have  a  central  plant  providing  for  manv  needs,  we  can  make  it  up  of  several 
units;  so  that,  when  the  need  falls  off,  we  can  leave  some  of  these  units 
unused. 

Ill 


PRINCIPLES  OF  ECONOMICS 

than  it  might  be  from  the  same  amount  of  capital,  were  it 
properly  distributed  between  the  instrument  (the  furnace)  and 
the  auxiliary  factor  (the  coal). 

In  the  second  place,  indivisible  factors,  if  also  porducible 
work  differently  from  divisible  in  another  respect.  While  they 
occasionally  have  a  wider  range  of  combination,  they  normally 
have  a  smaller  one  than  do  divisible  factors.  Thus,  a  single- 
unit  power  plant,  though  indivisible,  is  also  producible  and  so  can 
be  consciously  adapted  to  produce  most  advantageously  the  par- 
ticular output  which  will  normally  be  demanded  from  it.  This 
means  that  such  a  plant  will  normally  be  constructed  of  such  a 
size  that,  in  order  to  perform  its  task,  it  will  be  worked  in  a 
combination  little  if  any  beyond  the  one  of  maximum  efficiency, 
that  is,  the  one  giving  the  largest  average  per  unit  of  coal. 
This  would  coincide  with  the  maximum-efficiency  combination 
exactly  but  for  the  fact  that  the  larger  plant  costs  something 
more  than  the  smaller  and  so  the  saving  in  coal  is  partly  offset 
by  increased  interest  charges.  In  any  case,  there  will  be  just 
one  combination  in  which  an  indivisible  factor  will  normally  be 
worked  either  the  maximum-efficiency  combination  or 
one  but  little  beyond  it;  though,  under  exceptional  circum- 
stances, we  shall  work  it  in  the  first  or  ante-maxima  stage.  It 
should  be  added  that,  under  other  exceptional  conditions,  we 
shall  have  to  work  it  in  combinations  which  come  later  than  the 
normal  one.  If  circumstances  are  such  that  we  need  to  get  out 
of  a  particular  heating  plant  all  we  possibly  can  even  though 
fuel  is  thereby  used  wastefully,  we  naturally  drive  the  plant 
into  the  very  last  combination  which  shows  any  increase  over 
its  predecessors.  To  apply  these  various  considerations  to  the 
case  embodied  in  our  table,  a  plant  would  normally  be  used  in 
combination  6  or  anyhow  one  not  much  beyond;  but  in  times 
of  exceptionally  small  demand  it  would  be  used  in  any  from 
5  to  1,  while  in  times  of  exceptionally  great  demand  it  would 
be  used  in  10  or  11. 

Principle.  It  is  perfectly  normal  for  indivisible  factors  the 
supply  of  which  can  not  be  multiplied  indefinitely  to  be  worked 
in  either  the  increasing-returns  or  the  diminishing -returns  stage. 

Principle.  Indivisible  producible  factors  "vill  normally  be 
worked  in  the  combination  of  maximum  efficiency  or  in  one 
nearly  approximating  that,  but  will  at  times  be  used  in  some 

312 


CHAPTER  IV.     COMBINING  PROPORTIONS 

increasing  returns  or  some   later  diminishing   returns   combina- 
tion. 

Note :  The  point  embodied  in  the  principle  just  stated,  that 
indivisible  producible  factors  are  normally  used  at  or  near  the 
point  of  maximum  efficiency,  must  not  lead  us  to  think  that 
capital  in  general  is  being  used  in  this  stage.  The  combination 
of  maximum  efficiency  for  any  element  is  the  one  in  which  that 
element  appears  in  the  largest  proportion  in  which  it  can  be 
present  without  being  in  excess.  But  to  say  that  capital  in 
general  has  reached  this  stage  is  to  say  that  there  are  no  pos- 
sibilities left  in  the  way  of  machines,  roads,  bridges,  tunnels, 
etc.,  whereby  our  efficiency  could  be  increased, — a  statement 
which  is  obviously  untrue. 

3.     Heterogenous  Combinations. 

In  beginning  this  study  of  combining  proportions,  we  started 
with  the  case  of  simple  or  homogeneous  combinations  wherein 
the  assisting  factor  plays  just  one  role  with  respect  to  the  con- 
stant factor.  Thus,  we  thought  of  all  the  labor  used  on  a  piece 
of  land  as  devoted  to  cultivating  it  in  the  narrow  sense, — stirring 
the  soil — ;  so  we  thought  of  all  the  capital  used  on  the  land  as 
taking  the  form  of  fertilizer.  Still  more  perfect  cases  of  this 
sort  would  be  furnished  by  the  draft  animal  over  against  the 
food  supplied  to  it  or  the  furnace  over  against  the  coal  fed  to  it. 
But  we  hardly  need  say  that  the  combinations  of  the  real 
world  are  not  of  this  simple  character.  We  do  not  put  all  the 
labor  used  on  a  piece  of  ground  into  cultivating  it  or  all  the 
capital  into  fertilizer.  Instead,  some  of  the  labor  used  on  the 
land  is  devoted  to  preparing  the  soil,  some  to  seeding,  some  to 
cultivating,  and  so  on;  while  some  of  the  capital  is  spent  on 
tools,  some  on  seed,  some  on  fertilizer,  some  on  machines,  some 
on  storage  facilities,  and  so  on.  In  short,  in  real  life  we  have 
to  deal  with  cases  of  complex  combinations  wherein  the  new 
supplies  of  the  changing  factor  are  largely  set  to  performing 
new  functions  instead  of  just  performing  more  fully  the  old 
ones.  Now,  when  we  study  changing  combinations  from  this 
point  of  view,  how  greatly  do  we  need  to  modify  the  conclu- 
sions already  reached, — the  principles  already  laid  down? 

In  the  first  place,  we  of  course  still  have  the  possibility  of  a 
stage  of  returns  increasab'e  at  increasing  rate;  since  we  could 
have  this  if  there  were  only  one  function  which  the  changing 
factor  could  perform.  The  only  question,  then,  is  whether  the 
new  condition  tends  to  lengthen  this  first  stage.  In  general,  we 

ns 


PRINCIPLES  OF  ECONOMICS 

may  say  that  it  would  not  tend  to  modify  said  stage  at  all ;  since 
the  various  functions  are  of  different  degrees  of  importance  and 
the  more  important  ones  will  usually  be  performed  first,  so  that 
-a  second  function  would  naturally  be  taken  up  only  when  we 
had  passed  through  the  first  stage  completely.  To  this,  how- 
ever, an  important  exception  must  be  made.  It  is  always  pos- 
sible that  some  very  important  function  of  a  particular  factor 
can  be  undertaken  only  when  we  have  a  very  large  amount  of 
that  factor  available,  e.g.,  a  system  of  drainage  for  particularly 
productive  swamp  lands.  Accordingly,  a  great  increase  in  a 
particular  factor,  especially  capital,  may  suddenly  put  a  given 
tract  of  land  into  a  condition  of  greatly  increasing  returns.  This, 
however,  is  obviously  something  exceptional  which  merely  tem- 
porarily changes  the  course  of  things. 

We  have  noted  the  effect  of  our  new  hypothesis  on  the  in- 
creasing-returns stage.  What  is  to  be  said  as  to  that  of  dimin- 
ishing-returns?  Evidently  enough,  the  existence  of  additional 
functions  for  a  particular  factor  checks,  puts  a  brake  on,  the 
working  of  the  diminishing-returns  principle.  Before  we  have 
gone  far  into  the  diminishing  efficiency  stage  in  respect  to  one 
function,  other  functions  present  themselves  in  the  performance 
of  which  our  labor  and  capital  will  give  larger  returns  than  they 
would  if  devoted  to  the  fuller  performance  of  the  first  function. 
The  general  effect,  obviously,  is  to  prolong  the  diminishing 
efficiency  stage, — diminish  the  rapidity  of  its  downward  grada- 
tion. But,  while  the  new  condition  introduced  into  our  hypoth- 
esis checks  the  tendency  of  efficiency  to  fall  off,  it  surely  can 
not  destroy  that  tendency.  There  surely  are  not  left  unper- 
formed an  indefinite  number  of  functions  having  an  importance 
equal  to,  or  greater  than,  that  of  the  functions  already  provided 
for. 

ILLUSTRATIVE  PROBLEMS. 

1.  "Land   of  the   second  grade   will  not   be  brought  under 
cultivation  till  all  of  the  first  grade  has  been  cultivated  to  the 
point  of  diminishing  returns." 

Explain  what  is  meant  and  why  it  is  true. 

2.  "Very  many  pieces  of  capital,  e.g.,  a  hoe,  a  reaper,  are  of 
such  a  nature  that,  reckoning  by  periods  of  any  length    (say  a 
year),  they  simply  have  to  be  utilized  in  the  ante-maxima  stage." 

Explain  what  is  meant  and  why  it  is  true. 

3.  Show  that  the  'law  of   diminishing   returns   applies  to  a 
piece  of  land  used  as  a  site  for  an  office  building. 

114 


CHAPTER  IV.     COMBINING  PROPORTIONS 

4.The  following  quotation  which  is  taken  from  a  contempo- 
raneous discussion  of  the  law  of  diminishing  returns,  contains 
an  implied  application  of  that  law  which  is  quite  unwarranted. 
Explain  what  that  application  is  and  show  that  it  is  unwar- 
ranted. 

"It  might  be  supposed  that,  with  the  qualifications  stated,  the 
law  of  diminishing  return  in  this  simple  form,  as  applied  to  a 
certain  portion  of  land,  is  so  palpably  obvious,  so  axiomatic, 
that  it  could  never  have  been  overlooked.  There  is,  however, 
probably  no  other  economic  law  of  the  first  importance  which 
has  so  often  been  forgotten  or  miscalculated.  Mill  himself  has 
bestowed  extravagant  praise  on  the  ardour  and  perseverance  of 
peasant  proprietors,  although  it  is  certainly  true  that  much  of 
their  labour  is  pushed  far  beyond  the  point  of  diminishing  re- 
turn, and  is,  from  the  economic  standpoint,  wasted.  *  *  *  *  Be- 
fore recent  legislation  gave  the  Scottish  crofters  security 
of  tenure  and  fair  rents,  they  applied  labour  to  the  production 
of  corn, — in  this  case  barley  or  oats, — which  in  most  cases  had 
passed  the  point  of  diminishing  return  in  the  very  first  step 
taken.  *  *  *  *  In  Scotland,  generally,  the  farmers  are  probably 
the  most  enterprising  and  most  efficient  in  the  world ;  but  it  too 
frequently  happens  that  they  themselves  apply,  and  in  some  cases 
induce  their  landlords  to  apply,  capital  beyond  this  point  of 
diminishing  return." 

5.  "It  is  quite  impossible  to  believe  that  industry  as  a  whole 
\s  saturated  with  capital." 

Explain  what  is  meant  and  why  it  is  true. 

6.  "If  there  were  no  such  thing  as  the  law  of  diminishing 
returns,  a  man  having  a  one-horse  shop  could  become  a  million- 
aire in  a  few  years  by  simply  doubling  his  capital  from  year  to 
year."    Criticise. 

7.  •  "If    laiTfl    always    remained    in    the    stage    of    increasing 
returns   or    that   of   constant   returns,    it   could   never   have   any 
value  or  bear  any  rent."     Explain. 

8.  In  what  condition  as  respects  efficiency  would  you  expect 
industrial  plants  to  be  in  boom  times?  in  the  depressed  times  fol- 
lowing a  panic? 

9.  A  certain  boiler  is  evaporating  700  pounds  of  water  per 
hour  at  a  cost  of  100  pounds  of  coal,  while  it  could  evaporate 
1,225  pounds  of  water  at  a  cost  of  150  pounds  of  coal.     In  what 
stage,  as  respects  efficiency,  is  it  being  worked?     Prove. 

10.  A  certain  telephone  plant  takes  care  of  900  subscribers  at 
a  total  cost  per   annum  of  $4,700.     It  could  take  care  of   950 
subscribers  at  a  cost  of  $4,850.  -  In  what  stage  of  efficiency  is  it 
being  worked?     Prove. 

11.  "Transportation  is  not   in  the   stage  of  diminishing  re- 
turns, else  no  other  railroads  would  be  built.     If  existing  roads 
did   not  make  profits,  new   ones   would  not   appear."    Student's 
report.     Criticize. 

115 


PRINCIPLES  OF  ECONOMICS 

12.  Two   or   three  years   ago  the   Bell   Telephone   Company 
put  in  an  entirely  new  plant  at  Ann  Arbor.     In  what  stage,  as 
respects  returns,  is  that  plant  likely  to  be  at  the  present  time? 
Explain. 

13.  "The  telephone  plant  is  probably  in  the  state  of  increas- 
ing returns :  i.e.,  if  they  could  get  new  subscribers,  the  cost  of 
maintenance  would  not  increase  proportionally  to  the  increased 
rents  collected."     Criticise. 

Section     B.     The     Efficiency    of     Industries    as     Wholes    in 
Relation  to  Size  of  Output. 

One  of  the  most  important  applications  of  the  general  theory 
of  Combining  Proportions  and  Product  respects  the  capacity  of 
any  particular  quantity  of  any  factor,  say  land,  to  increase  its 
output,  with  the  aid  of  an  increasing  quantum  of  auxiliary 
factors,  in  response  to  an  increasing  demand.  We  are  trying 
to  get  more  product  out  of  a  given  farm,  what  success  do  we 
have?  Now,  this  problem  is  important  in  itself,  particularly 
to  the  owner  of  the  farm.  But  there  is  another  problem,  de- 
pending largely  for  its  solution  on  the  solution  of  this  first 
problem,  which  is  of  much  greater  importance  to  people  gen- 
erally as  distinguished  from  the  owner  of  a  particu'ar  farm. 
This  second  and  more  important  problem  asks,  not  what  success 
shall  we  have  if  we  try  to  get  more  product  from  a  particular 
piece  of  ground,  but  rather  what  success  shall  we  have  if  we  try 
to  get  a  larger  product  from  some  particular  industiy--say 
wheat  raising — taken  as  a  whole. 

Note:  This  new  problem  does  not,  like  the  first  one,  require 
us  to  keep  one  of  the  factors,  land,  constant : — we  may  devote 
to  the  industry  under  consideration,  not  only  more  capital  and 
labor,  but  also  more  land.  It,  therefore,  seems  so  different  a 
problem  from  that  already  considered  as  to  make  their  study 
under  the  same  topic  scarcely  legitimate.  Anyhow,  to  make  use 
in  this  connection  of  the  same  terminology  as  that  hitherto  em- 
ployed seems  of  very  questionable  propriety.  To  talk  about  a 
stage  of  diminishing  returns  for  a  combination  in  which  one  of 
the  factors  remains  fixed  in  amount  and  then  use  the  same 
expression  for  a  whole  industry  in  which  all  the  factors  may 
change  in  amount  seems  a  very  unscientific  procedure.  In 
respect  to  the  propriety  of  considering  the  two  problems  to- 
gether, it  is  to  be  said  that  they  are  in  fact  very  closely  con- 
nected. Whether  or  not  an  industry  as  a  whole  is  in  the  state 
of  diminishing  returns  or  in  that  of  increasing  returns  depends, 
for  one  thing  surely,  on  whether  the  particular  factors  em- 
ployed in  that  industry  are  in  said  state.  In  respect  to  the  mat- 

110 


CHAPTER  IV.     COMBINING  PROPORTIONS 

ter  of  terminology,  to  make  these  very  diverse  uses  of  certain 
phrases  is  surely  bad;  but  it  is  too  well  established  in  usage 
to  be  thrown  out  at  the  present  time. 

Taking  up,  now,  the  matter  of  possibilities  for  industries  as 
wholes,  and  assuming  general  conditions  to  remain  constant,  we 
surely  have  results  which,  in  form  at  least,  are  analogous  to 
those  already  reached  in  our  study  of  individual  factors.  Any 
industry,  taken  as  a  whole,  if  we  were  to  try  to  get  from  it  all 
quantities  of  output  from  a  very  small  amount  up,  would  be 
found  at  some  time  or  other  in  each  of  the  following  condi- 
tions or  stages:  (1)  output  increasable  at  increasing  i'c.te  or 
diminishing  cost,*  (2)  output  increasable  at  constant  rate  or 
constant  cost,  (3)  output  increasable  at  diminishing  rate  or 
increasing  cost,  (4)  maximum  output  or  maximum  cost,  and 
(5)  output  actually  diminishing.  This  last  of  course  would 
never  be  realized,  just  as  in  our  former  case,  because  it  would 
be  foolish  to  expend  effort  in  diminishing  rather  than  increas- 
ing product.  The  fourth  stage  would  be  merely  a  point  as  in 
our  preceding  case;  since  there  could -be  but  one  maximum  out- 
put. The  second  stage,  however,  would  not  as  in  our  original 
case  be  a  mere  turning  point  from  increasing  to  diminishing 
returns.  Conditions  would  be  constantly  occurring  under  which 
the  quantity  producible  without  any  material  change  in  cost 
would  be  so  considerable  that,  during  periods  sufficiently  long 
to  make  the  matter  of  much  practical  importance,  we  should  be 
getting  the  necessary  increases  in  output  with  only  a  propor- 
tional increase  in  expenditure. 

The  above  paragraph  has  dogmatically  asserted  for  every 
industry  the  existence  of  three  different  stages  in  which  it 
might  be  found  under  a  perfectly  rational  procedure.  Let  us 
take  a  moment  to  confirm  this  statement.  In  respect  to  the 
first  stage,  diminishing  cost,  we  should  expect  its  existence  for 
two  or  three  reasons.  First,  the  moment  we  come  to  deal  with 
industries  as  wholes,  we  strike  the  matter  of  possible  increase  in 
specialization.  Thus,  if  the  amount  of  product  which  we  must 
get  from  an  industry  is  large  enough,  we  can  carry  very  far 
geographical  specialization,' — raising  potatoes  or  apples  or  water- 
melons from  the  lands  preeminently  adapted  for  raising  them; 
and  this,  of  course,  means  more  than  proportionally  increased 
returns  for  our  expenditure  and,  therefore,  diminishing  costs. 

*For  the  sake  of  convenience  we  will  commonly  employ  the  "cost"  rather 
than  the  "returns"  phrase. 

117 


PRINCIPLES  OF  ECONOMICS 

A  second  reason  for  this  result  is  to  be  found  in  the  fact  that 
calling  on  a  given  industry  for  an  enlarged  output  means  that 
increasing  resort  may  be  had  to  large-scale  methods.  We  can 
make  more  use  of  machinery,  can  have  greater  specialization 
within  each  plant,  and  so  on.  All  this  means  diminishing  costs. 

But,  again,  it  surely  can  not  be  questioned  that  every  in- 
dustry would  sooner  or  later  get  into  the  diminishing  returns 
or  increasing  cost  stage.  One  fundamental  factor  of  industry, 
land,  is  absolutely  limited  in  amount.  Every  single  piece  of  it 
is  surely  subject  to  the  instrumental  law  of  diminishing  returns, 
and  so,  of  course,  the  total  is  subject  to  that  same  law.  It 
follows  that,  even  if  all  the  land  were  equally  good  for  the 
purposes  of  a  given  industry  and  we  could  afford  to  put  all  of 
it  to  the  service  of  that  industry,  there  would  surely  come  a 
time  when  increased  expenditure  was  not  followed  by  propor- 
tionally increased  reward, — when  increase  in  product  meant 
more  than  proportional  increase  in  cost.  But  we  ha'rdly  need 
3ay  that  not  all  lands  are  equally  good  for  the  uses  of  any 
particular  industry.  Whether  because  of  location  or  of  qual- 
ities which  could  be  altered  only  at  an  impossible  expenditure, 
they  differ  greatly  in  fitness  for  a  given  purpose.  In  conse- 
quence, land  as  such  comes  under  the  dominion  of  the  law  of 
diminishing  returns  (returns  increasable  at  diminishing  rate) 
much  sooner  than  it  would  under  the  former  hypothesis. 

But,  it  may  be  asked,  would  not  the  considerations  adduced 
above  to  show  that  we  may  have  a  condition  of  increasing  re- 
turns prove  that  we  might  go  on  indefinitely  without  ever  reach- 
ing the  stage  of  diminishing  returns.  May  not  the  advantages 
derivable  from  greater  specialization  or  from  an  increased  resort 
to  large-scale  methods  forever  save  us  from  falling  into  that 
dread  condition?  The  answer  must  surely  be  a  negative  one. 
There  certainly  is  a  limit  to  the  advantages  derivable  from 
specialization  and  large-scale  production.  Every  industry  what- 
soever, if  called  upon  to  increase  its  output  indefinitely,  would 
ultimately  pass  into  a  stage  of  diminishing  efficiency  or  increas- 
ing cost. 

But,  not  only  would  every  industry  under  the  conditions  of 
our  experiment,  inevitably  be  at  some  time  or  other  in  the 
condition  of  diminishing  cost  and  at  another  in  that  of  increas- 
ing cost,  in  many  cases  anyhow,  it  would  at  some  time  or  other 
be  in  the  condition  of  substantially  constant  cost.  This  merely 

118 


CHAPTER  IV.     COMBINING  PROPORTIONS 

means  that  the  transition  from  the  condition  of  diminishing 
cost  to  that  of  increasing  cost  is  not  a  mere  point,  but  may- 
extend  over  a  considerable  change  in  the  volume  of  output. 
When  we  remember  that,  in  this  case  of  industries  as  wholes,  we 
are  at  liberty  to  increase  all  the  factors  so  long  as  more  of  the 
stock  of  each  is  available,  the  possibility  of  such  a  condition  of 
constant  cost  seems  plain  enough.  Land,  of  course,  is  the  factor 
which  is  most  likely  to  fail  us.  Yet  it  surely  must  be  admitted 
that  there  are  many  pieces  of  ground  of  substantially  the  same 
grade  of  efficiency,  counting  location,  fertility,  etc.;  and,  until 
all  of  the  best  grade  had  been  put  to  use,  the  particular  industry 
involved  would  be  getting  out  its  product  at  unchanging  cost, — 
supposing  no  change  in  technical  conditions.  But  the  case  is 
still  clearer  with  industries  which  do  not  need  so  large  a  propor- 
tion of  land.  Just  because  of  this  fact,  the  number  of  sites 
which  are  of  substantially  equal  efficiency  for  the  industry  in 
question  is  in  excess  of  the  need,  and,  so,  production  can  ex- 
pand without  being  checked  by  the  scarcity  of  the  only  factor 
which  is  strictly  limited. 

We  have  argued  that  any  industry,  taken  as  a  whole,  may 
be  in  any  one  of  the  three  stages  as  respects  the  relation  of 
cost  to  increasing  output.  It  should  be  added  that  these  stages 
may  alternate  with  one  another  in  any  order.  An  industry  may 
be  at  one  time  in  the  condition  of  constant  cost,  then  in  that 
of  diminishing  cost,  then  in  that  of  constant  cost  again,  then  in 
that  of  diminishing  cost,  and  so  on.  More  particularly,  for 
every  change  there  will  be  a  period  of  constant  cost.  If  the 
enlarged  demand  for  copper  causes  marginal  cost  to  rise  to  20 
cents,  and  if,  at  this  marginal  cost,  output  can  be  expanded,  let 
us  suppose,  to  any  figure  between  700  millions  pounds  and  900 
millions ;  then,  for  a  period  during  which  demand  ranges  no 
more  widely  than  this,  copper  would  be  a  constant-cost  good. 

We  have  seen  that  any  industry  may  be  in  any  one  of  three 
conditions:  diminishing  cost,  constant  cost,  and  increasing  cost. 
But  we  should  naturally  expect,  and  experience  confirms  the 
expectation,  that  some  industries  would  be  preponderantly  in 
tfie  first  stage,  others  in  the  second,  still  others  in  the  third. 
Thus,  it  is  the  accepted  opinion  among  authorities  on  railway 
transportation  that  this  industry  is  preponderantly  in  the  con- 
dition of  diminishing  cost  or  increasing  returns.  Again,  there 
can  be  no  doubt  that  a  large  number  of  common  manufacturing 

119 


PRINCIPLES  OF  ECONOMICS 

industries  are  most  of  the  time  in  a  condition  of  constant  cost. 
Finally,  the  so-called  extractive  industries,  looked  at  in  the 
long  run  anyhow,  are  commonly  viewed  as  in  the  condition  of 
increasing  cost:  if  we  insist  on  using  considerably  larger  quan- 
tities of  copper,  silver,  cotton,  wheat,  etc.,  we  shall  have  to  con- 
sent to  incur  a  higher  cost  in  acquiring  them.  These  distinctions 
among  commodities,  as  will  appear  in  Chapter  IX,  furnish  the 
classification  of  producible  commodities  commonly  used  in  the 
study  of  normal  value. 

Up  to  this  point  in  our  discussion  of  the  effects  on  cost  of 
attempts  to  increase  the  output  of  any  industry,  we  have 
assumed  in  a  general  way  the  maintenance  of  conditions  which, 
in  respect  to  fundamentals,  are  static,  unchanging.  A  particular 
industry  is  in  the  condition  of  increasing  cost,  it  being  assumed 
that  methods  remain  constant,  save  in  so  far  as  these  experience 
the  changes  natural  to  the  changing  scale  of  production.  It  is 
of  course  possible,  and  often  probable,  that  the  course  of  dis- 
covery and  invention  will  make  the  production  of  refined  petrol- 
eum cheaper  next  year  than  it  is  this  year.  In  consequence,  the 
cost  of  furnishing  an  output  500  millions  gallons  larger  than 
the  present  one,  may  prove  a  smaller  cost  per  unit  than  the 
cost  now  incurred.  This,  however,  would  not  disprove  the 
statement  that  the  petroleum  industry  is  in  the  condition  of 
increasing  cost.  Such  a  statement  in  any  field  of  study  assumes 
static  conditions.  It  is  of  course  permissible  for  persons  to 
insist  on  taking  into  account  possible  changes  of  a  fundamental 
sort,  whenever  they  make  statements  with  respect  to  the  cost 
conditions  of  an  industry.  But,  in  that  case,  the  difference  in 
the  assumption  set  out  from  should  be  made  clear.  It  is  surely 
of  no  advantage  to  contradict  with  heat  the  statement  of  some 
other  writer  when  you  are  understanding  that  siatement  in  a 
sense  quite  different  from  the  way  in  which  he  understands  it. 
Assuming  that  both  these  methods  of  interpreting  such  affirma- 
tions are  legitimate,*  they  ought  to  be  distinguished  as  being, 
respectively,  static  and  dynamic  assertions  with  respect  to  the 
present  condition  of  the  industry  in  question. 


*This  assumption  is  of  doubtful  validity.  The  affirmation  naturally 
means  that  the  larger  output  will  cost  less  per  unit  than  the  smaller.  The 
dynamic  interpretation  makes  it  mean  that  the  future  product  will  cost  less 
than  the  present. 

120 


CHAPTER  IV.    COMBINING   PROPORTIONS 

Summarizing  the  discussions  of  this  section  we  have  the 
following  principles : 

Principle.  Every  industry,  if  called  on  in  successive  pro- 
duction periods  to  increase  its  output  from  some  very  small 
quantity  to  the  largest  possible,  will  appear  at  some  time  or 
other  in  each  of  the  following  stages  or  conditions:  (i)  dimin- 
ishing cost,  (2)  constant  cost,  (3)  increasing  cost,  and  (4)  max- 
imum output, — static  conditions  being  assumed. 

Principle.  At  any  particular  time,  some  industries  will 
normally  be  in  the  condition  of  diminishing  cost,  some  in  that 
cf  constant  cost,  some  in  that  of  increasing  cost. 

ILLUSTRATIVE  PROBLEMS. 

1.  Argue  for  the  reasonableness  of  the  proposition  that,  if 
the  marginal  cost  of  producing  copper  should  rise  from,  say,  20 
to  25  cents  per  pound,  at  the  latter  figure  this  industry  would 
probably  be  for  a  time  a  constant  cost  industry. 

2.  Give  some  reasons  for  believing  that  railway  transporta- 
tion is  likely  to  be  much  of  the  time  in  the  condition  of  dimin- 
ishing cost  (increasing  returns). 

3.  "Silver,    iron,    wheat,    meat ,   etc.,    without    much    doubt 
should  be  classed  as  increasing-cost  products." 

(a)  What  does  this  mean? 

(b)  Argue   for  the  reasonableness   of   the  statement 

4.  "Agriculture   in   Virginia    is    in   the   condition   of    dimin- 
ishing returns,  as  the  land  is  worn  out." 

Show  that  this  misapprehends  the  meaning  of  the  phrase 
diminishing  returns. 

5.  An  industry   like  the   making   of   surgical   instruments   is 
likely  to  be  in  what  condition  ?     Explain. 

6.  "The  ga-s  business  in  Ann  Arbor  is  in  the  condition  of 
increasing    returns;    since   fixtures    and   pipe    could   be   put   into 
many  more  houses  with  small  additional  expense  proportionately 
to  the  returns  gotten  from  the  new  patrons." — Student's  Report. 
Show  that  the  writer  did  not  understand  what  is  meant  by  the 
condition   of   increasing   returns. 

7.  "The  price  of  increasing-cost  goods  tends  to  equal  their 
marginal  cost  of  production." 

(a)  What  do  you   suppose   is   meant  by   the  phrase   "mar- 
ginal cost  of  production"? 

(b)  Show  that  the  proposition  laid  down  does  not  give  a 
very  definite  idea  of  what  the  price  of  such  goods  will  be  next 
year,  even  if  we  know  their  marginal  cost  now. 

8.  Suppose   that,    while   competition    in   the    industry    is    still 
maintained,  the  conditions  of  production   for  a  particular  type 

121 


PRINCIPLES  OF  ECONOMICS 

of  wooden  chair  are  such  that,  if  fewer  than  1,000  chairs  a  year 
are  produced,  the  cost  per  chair  will  be  about  $3 ;  that,  if  output 
is  between  1,000  and  20,000,  cost  will  be  about  $2;  that  if  it  is 
between  20,000  and  50,000,  cost  will  be  $1;  if  between  50,000  and 
500,000,  50  cents;  if  between  500,000  and  2  millions,  HO  cents; 
if  between  2  millions  and  3  millions,  40  cents;  If  between  3  and 
4  millions,  55  cents;  if  between  4  and  5  millions,  75  cents;  if 
between  5  and  6  millions,  $1.25;  and  so  on. 

(a)  Suppose  that  in  the  year  1906,  700,000  of  these  chairs 
are  produced;  that  by  1915  the  output  has  increased  to  1,300,000; 
that  by  1925  the  amount  is  1,600,000;  and  that  by  1940  it  is 
1,800,000.  To  what  class  of  goods  would  these  chairs  belong 
during  the  period  1906  to  1940,  looked  at  as  a  whole? 

(b)  Suppose  that  between  1950  and  2000  the  output  should 
increase  from  from  2,300,000  to  6  millions.  To  what  class  of 
goods  would  these  chairs  belong  during  that  59  years,  looked 
as  at  a  whole? 

Section  C.     The  Efficiency  of  Countries  as  Wholes  in  Rela- 
tion to  Volume  of  Output. 

In  the  preceding  section  we  applied  our  analysis  of  the 
general  relations  of  Combining  Proportions  and  Product  to  the 
problem  of  how  industries  as  wholes  behave  when  called  on  to 
increase  their  total  output.  We  now  come  to  the  most  im- 
portant problem  of  all, — how  countries  or  communities  as 
wholes  respond  to  such  a  demand.  At  any  given  moment  the 
United  States  has  a  particular  outfit  of  natural  resources,  of 
capital,  and  of  labor.  What  will  be  the  effect  of  trying  to  in- 
crease the  total  product  obtainable  from  this  outfit  by  increas- 
ing the  proportion  of  one  of  the  factors,  say  capital  or  labor? 
This  is  surely  a  question  of  much  significance  to  all  of  us,  but 
more  especially  to  the  particular  class  of  persons  who  are 
responsible  for  the  particular  factor  which  is  increasing.  This 
grows  out  of  the  principle,  already  noted  (p  102)  and 
later  to  be  explained,  that,  under  the  normal  working  of  the 
law's  of  price,  each  contributor  tends  to  get  that  return  which 
expresses  the  significance  of  the  marginal  contribution  of  his 
class;  from  which  fact  it  follows  that,  if  the  increase  in  his 
class  lowers  its  marginal  product,  he  will  get  a  smaller  return. 
Accordingly,  we  now  undertake  to  determine  how  changes  in 
the  total  stock  of  any  particular  factor  belonging  to  a  partic- 
ular community  affects  its  productive  capacity  in  general. 

It  is  hardly  necessary  to  say  that  the  question  before  us 
is  one  of  much  complexity.  At  first  sight  it  seems  natural  to  give 

122 


CHAPTER  IV.    COMBINING  PROPORTIONS 

that  question  a  dynamic  interpretation.  We  would  seem  to  be 
most  interested  in  what  is  actually  going  to  happen  in  the  real 
world,  not  in  what  would  happen  under  theoretically  static  con- 
ditions. Doubtless  this  is  true  to  some  extent;  but  generally 
speaking,  our  highest  interest  is  still  in  the  problem  under  static 
conditions.  Even  if  we  are  fortunate  enough  to  escape  the  nat- 
ural penalty  of  excessive  population  because  of  greater  tech- 
nical efficiency,  this  does  not  excuse  our  folly.  We  should  be 
still  better  off  if  population  were  smaller;  since,  by  hypothesis, 
the  lower  cost  of  production  has  no  connection  with  the  in- 
crease of  population,  but  results  from  discovery  and  invention. 
Accordingly,  we  ask  ourselves  the  question  whether  communities 
as  such,  static  conditions  being  assumed,  show  themselves  sub- 
ject to  the  same  laws  of  return  already  considered,  exhibiting 
themselves  in  the  several  stages  of  increasing,  constant,  dimin- 
ishing, and  maximum  returns  with  which  we  are  now  familiar, 
and,  if  so,  what  variations  from  the  results  previously  met  with 
are  here  to  be  noted. 

To  the  general  question  whether  countries  or  communities, 
considered  as  wholes,  show,  under  static  conditions,  the  same 
stages,  as  respects  the  relation  of  efficiency  to  changes  in  total 
output,  there  surely  can  be  but  one  answer, — the  affirmative  one. 
In  the  first  place,  every  country  of  any  size  is  certain  to  be  in 
the  condition  of  increasing  returns  or  increasing  efficiency  in 
the  earlier  stages  of  its  development.  This  is  not  to  say  that 
any  particular  piece  of  ground  will  necessarily  be  employed  in 
that  condition ;  as  we  said  earlier,  farmers  would  work  the  land 
actually  at  the  point  of  maximum  efficiency  simply  by  keeping 
a  portion  of  the  land  out  of  cultivation,  spending  their  efforts  on 
a  smaller  piece.  But,  in  dealing  with  a  country  as  a  whole,  the 
case  is  quite  different.  Here  the  element  of  organic  combina- 
tion comes  in.  To  get  the  most  out  of  our  outfit  of  land  we 
have  to  treat  it  as  a  sort  of  manufacturing  plant,  an  indivisible 
unit,  having  many  parts  coordinated  into  a  functional  whole. 
Thus,  our  natural  store  of  the  metals  is  to  be  found  only  in  a 
few  places ;  only  a  small  territory  can  be  used  for  raising  trop- 
ical and  semi-tropical  products;  and  so  on.  It  follows  that  the 
best  use  of  the  whole  involves  geographical  specialization, 
which,  like  all  specialization,  is  possible  only  with  a  large 
market,  and  this  must  depend  on  a  large  population.  Further, 
some  parts  of  our  natural  plant  are  built  on  a  very  large  scale 

J23 


PRINCIPLES  OF  ECONOMICS 

and  could  not  be  utilized  at  all  or  could  be  utilized  only  in  a  very 
petty  way,  unless  we  had  a  large  population.  For  example,  we 
had  from  the  first  the  basis  of  a  magnificent  system  of  water 
transportation  in  the  great  lake  chain ;  but  it  is  only  as  popu- 
lation has  developed  all  through  this  region  that  we  could 
begin  to  utilize  this  great  outfit  at  all  fully.  The  harbors  of  a 
country  also  illustrate  this  idea  of  an  indivisible  natural  plant, 
which  requires  a  great  population  and  a  great  commerce  to 
secure  its  utilization  to  the  point  of  maximum  efficiency. 

We  have  seen  that  any  country  taken  as  a  whole  is  certain, 
in  the  days  of  its  early  development,  to  be  in  the  condition  of 
ante-maximum  efficiency,  increasing  returns.  It  is  no  less 
certain  that  a  country  is  likely  to  remain  for  a  longer  or  shorter 
period  in  the  condition  of  constant  returns.  After  population 
and  capital  have  developed  to  a  point  where  the  country  is  be- 
ing utilized  at  substantially  its  best,  there  are  still  unexhausted 
resources,  possibilities,  of  the  same  general  grade  as  those 
already  used.  The  larger  the  country  and  the  more  diversified 
its  natural  resources,  the  greater  are  these  possibilities.  Further, 
some  of  the  industries  of  a  country  continue  to  be  in  the  condi- 
tion of  increasing  returns  after  the  greater  number  have  passed 
that  stage.  The  actual  condition  would  then  be  a  resultant 
of  counteracting  forces  and  might  easily  be  a  condition  of  con- 
stant returns. 

Again,  it  can  not  be  doubted  that  some  time  or  other  the 
country  will  be  in  the  condition  of  diminishing  returns — re- 
turns increasable  but  at  a  diminishing  rate.  It  is  of  course 
possible  that  some  industries  would  never  in  practice  be  pushed 
into  this  stage,  since  the  major  part  of  human  effort  would 
necessarily  be  spent  on  the  great  basal  industries, — the  industries 
which  cater  to  the  common,  universal  needs.  But,  in  the  case 
of  the  basal  industries  anyhow,  there  would  surely  come  a  time 
when  we  could  not  increase  product  save  at  greater  cost  per 
unit.  The  considerations  already  brought  out  would  doubt- 
less delay  the  coming  of  this  condition;  but  it  would  certainly 
come  at  last.  The  advantages  to  be  derived  from  larger  scale 
and  from  a  more  perfect  coordinating  of  social  resources  are 
surely  exhaustible,  though  the  time  of  their  exhaustion  may  be 
more  remote  than  is  commonly  supposed. 

Finally,  it  is  surely  conceivable,  though  the  possibility  is  not 


CHAPTER  IV.    COMBINING   PROPORTIONS 

likely  to  prove  of  great  practical  significance,  that  a  time  will 
come  when  output  can  no  longer  be  increased  at  all. 

We  have  insisted  that,  broadly  speaking,  any  country,  taken 
as  a  whole,  may  be  brought  into  any  one  of  the  four  possible 
stages.  We  now  must  emphasize  a  point  already  more  or  less 
sharply  brought  out  by  implication;  viz.,  this,  that  the  process 
of  passing  through  all  the  stages  is  vastly  slower  in  the  case  of  a 
whole  country  than  in  the  case  of  a  single  piece  of  ground.  Any 
country,  taken  as  a  whole,  may  be  undermanned,  under-popu- 
lated for  a  long  period.  Increases  in  population  may  increase 
product  more  than  proportionately  or  at  least  proportionately, 
for  many  years,  even  for  centuries.  In  addition  to  the  consid- 
erations bearing  on  this  point  which  have  already  been  brought 
forward,  the  following  may  be  adduced.  The  industry  of  a 
whole  nation  is  a  complex  of  many  different  industries.  Now, 
as  already  seen,  industries  do  not  pass  into  the  diminishing 
stage  with  equal  rapidity.  Some  industries  almost  never  reach 
this  stage.  Taking  a  country  as  a  whole,  in  respect  to  some 
part  of  its  economic  activity,  it  has  probably  reached  the  dimin- 
ishing returns  stage;  in  respect  to  another  part,  it  is  in  the 
constant  returns  stage;  and,  in  respect  to  another  part,  in  the 
increasing  returns  stage.  In  so  far  as  increase  of  population 
means  undertaking  to  increase  output  from  the  second  and  third 
groups,  a  condition  of  diminishing  returns  is  shut  out  at  once; 
it  is  only  from  the  diminishing  returns  group  of  industries  that  a 
condition  of  diminishing  returns  for  the  country  as  a  whole  can 
be  reached.  Now,  it  is  doubtless  true  that  the  new  demand 
created  by  a  general  increase  in  population  falls  with  rather 
disproportionate  weight  on  the  extractive  industries,  especially 
stock  raising  and  agriculture,  and,  therefore,  on  industries  in 
which  the  stage  of  diminishing  returns  is  reached  at  an  early 
date.  Yet  this  can  be  overstated.  Very  important  elements  even 
in  the  extractive  industries  are  those  parts  which .  are  con- 
cerned with  the  transporting  and  exchange  of  products.  But, 
as  already  explained,  the  transportation  industries  are  believed 
to  be  most  commonly  in  the  state  of  increasing  returns,  and 
the  exchange  industries  are  usually  in  the  condition  of  constant 
returns. 

We  have  seen  that  a  country  as  a  whole  is  naturally  much 
slower  in  reaching  the  point  of  diminishing  returns  than  any 
single  piece  of  land  in  that  country.  It  seems  even  more  cer- 

125 


PRINCIPLES  OF  ECONOMICS 

tainly  true  that  a  country  will  remain  almost  indefinitely  within 
this  diminishing  returns  stage.  That  is,  an  industrious,  thrifty, 
and  ingenious  people  seem  to  be  able  to  increase  almost  in- 
definitely the  density  of  population  without  reaching  the  point 
where  returns  altogether  cease  to  expand.  The  new  people  have 
to  content  themselves  with  a  lower  and  lower  standard  of  liv- 
ing; but  they  add  something  to  the  total  output,  and,  therefore, 
do  not  have  to  starve. 

In  the  foregoing  discussion  of  the  behavior  of  a  country 
taken  as  a  whole,  we  have  assumed  that  the  fundamental  condi- 
tions of  production  are  unchanged — a  static  order  of  things  pre- 
vails. If,  now,  we  admit  the  dynamic  element,  leaving  the  way 
open  for  changes  in  productive  efficiency  brought  about  by  dis- 
covery and  invention,  we  must  emphasize  still  more  strongly 
the  point  just  made,  that  a  country  as  a  whole  passes  with  very 
great  slowness  through  the  several  stages, — especially  the  dimin- 
ishing returns  stage.  It  has  in  fact  always  been  recognized  by 
economists  that  the  principle  of  diminishing  returns  is  liable  to 
be  offset  at  any  time  by  improvements  in  method.  The  100 
millions  units  of  today  may  be  less  easily  produced  than  the 
200  of  tomorrow.  This  is  not  necessarily  a  real  suspension  of 
the  true  law  of  diminishing  returns ;  since  that  law  means  that 
the  200  millions  of  tomorrow  will  be  produced  with  greater 
proportional  difficulty  than  the  100  millions  of  tomorrow; — and 
this  probably  would  continue  to  be  true.  But,  while  not  a  true 
suspension  of  our  law,  this  fact  of  improving  methods  miti- 
gates greatly  the  harshness  of  the  consequences  of  that  law,  and 
so  is  of  much  significance  and  advantage  to  society.  The  man 
who  is  attempting  to  predict  the  future  economic  condition  of 
society  must  surely  take  account  of  these  possible  changes  in 
the  fundamental  methods  and  processes  of  production. 

Principle,  (a)  Countries,  taken  as  wholes,  like  individual 
industries,  may  be  found  in  the  condition  of  increasing  returns 
or  in  that  of  constant  returns  or  in  that  of  diminishing  returns 
or  in  that  of  maximum  returns. 

(b)  Countries,  taken  as  wholes,  are  consequently  subject  to 
the  so-called  Law  of  Diminishing  Returns;  i.  e.,  the  time  will 
come  when   efforts   to   increase   total   output   can   succeed   only- 
through  more  than  proportionate  increase  in  expenditure. 

(c)  The  stocks  of  the  several  productive  factors  belonging 
to  any  country  are  subject  to  the  so-called  Law.  o.f  Diminishing 

UQ 


CHAPTER  IV.    COMBINING   PROPORTIONS 

Productivity;  i.  e.,  the  time  will  come  when  the  marginal  pro- 
ductivity of  any  factor  will  vary  inversely  as  its  quantity. 

(d)  Countries  as  wholes  and  their  stocks  of  factors  reach, 
and  pass  through,  the  diminishing  returns  or  diminishing  pro- 
ductivity stage  more  slowly  than  do  individual  factors  or  in- 
dustries. 

(e}  The  tendency  of  a  country  or  any  one  of  its  factors  to 
show  diminishing  returns  or  diminishing  productivity  can  always 
be  temporarily  offset  by  discovery  or  invention. 

ILLUSTRATIVE  PROBLEMS. 

1.  "On.  the  whole  I  am  disposed  to  think  that  the  United 
States  is  still  undermanned." 

(a)  Explain  what  is  meant. 

(b)  Argue  for  the  correctness  of  the  opinion  given. 

2.  "If  laborers  would  accept   low  enough   wages,   it   would, 
under  normal  conditions,  be  almost  impossible  for  employment 
to  fail." 

Argue  for  the  correctness  of  the  above  statement. 

3.  "All   land   is  subject  to  the  law   of   diminishing  returns. 
Consequently,  every  increase  in  population  means  that  the  mar- 
gin of  cultivation  has  to  be  pushed  lower,  that  the  food  of  the 
masses  costs  more  than  before,  and  so  the  amount  of  poverty 
ever  increases." 

Objector.  "Such  talk  is  all  nonsense.  There  is  no  law  of 
diminishing  returns.  It  costs  less  to  raise  a  bushel  of  wheat 
now  than  it  did  a  hundred  years  ago.  The  real  trouble  is  that 
the  existence  of  a  right  of  private  property  in  land  causes  an 
ever  increasing  share  of  the  product  of  industry  to  go  to  land- 
lords in  the  'shape  of  rent." 

(a)  Explain    the    meaning    of    the    clause:    "the    margin    of 
cultivation  has  to  be  pushed  lower." 

(b)  Does  the  fact  (supposing  it  to  be  a  fact)   that  "it  costs 
less  to  raise  a  bushel  of  wheat  now  than  it  did  a  hundred  years 
ago"    justify   the    sweeping   statement   that   there    is   no    law    of 
diminishing  returns?     Explain. 

•  (c)     Formulate  a  proposition  which  it  would  justify. 

(d)  If  there  were  no  law  of  diminishing  returns  in   some 
sense  or  other,  could  any  of  the  product  go  to  the  landlord  as 
rent?     Explain. 

(e)  If  the  law  of   diminishing  returns  were  not  true  even 
dynamically,  could  "an  ever  increasing  share  of  the  product  of 
industry  go  to  landlords"?     Explain. 

4.  If    population    keeps    on    increasing   as    at    present,    every 
year  is  going  to  make  the  feeding  of  the  race  more  difficult." 

Show  that  the  above  conclusion  does  not  necessarily  follow 
from  the  law  of  diminishing  returns. 

127 


CHAPTER  V. 
THE  MECHANISM  OF  EXCHANGE. 

With  the  present  chapter,  we  begin  the  study  of  that  topic 
which  forms  much  the  most  important  part  of  Economics,  i.  e., 
Exchange.  The  first  matter  to  be  considered  under  this  head  is 
the  Mechanism  of  Exchange,  i.  e.,  the  instruments  and  processes 
through  which  exchanging-  is  effected.  This  involves  going  into 
the  study  of  industrial  technique  more  fully  than  is  contemplated 
in  our  general  plan.  But  the  difficulty  of  this  technique  in  the 
case  before  us  and  the  need  for  pretty  full  knowledge  of  it  as  a 
preparation  for  the  study  of  the  principles  involved,  make  this 
seeming  inconsistency  necessary. 

Section  A.     Money  Exchange. 

The  most  obvious  and  natural  form  of  exchange  is  manifestly 
the  direct  exchanging  of  goods  for  each  other, — barter,  as  it  is 
called.  Mr.  A  who  has  wood  to  spare  and  wants  a  harness, 
gets  into  communication  with  Mr.  B  who  has  a  harness  to  spare 
and  wants  wood,  and  a  mutual  exchange  is  effected.  But  no 
argument  is  needed  to  convince  any  one  that  this  method  of 
effecting  exchanges  must,  generally  speaking,  be  highly  incon- 
venient and  altogether  inadequate.  The  necessary  coincidence 
between  exchangers  as  respects  the  kinds  and  amounts  of  goods 
wanted  and  offered,  is  one  which  would  be  realized  only  in 
exceptional  cases  and  even  then  would  be  discovered  only  after 
considerable  trouble.  Quite  likely  there  is  no  one  who  wants 
the  goods  offered  by  Mr.  A  and  at  the  same  time  can  supply 
the  goods  wanted  by  Mr.  A.  The  only  solution  of  the  problem 
would  often  be  a  triangular  arrangement,  by  which  Mr.  A  dis- 
poses of  his  surplus  to  Mr.  B  and  gets  the  equivalent  desired 
from  Mr.  C.  Doubtless  it  would  be  possible  to  work  out  such 
a  solution  by  means  of  a  complicated  system  of  credit  barter. 
But  a  simpler  solution  is  the  one  actually  in  use  which  may  be 
called  mediated  exchange;  by  which  we  mean  exchange  where 
in  a  third  something  comes  in  to  act  as  a  middle  term  between 
the  two  kinds  of  goods  which  Mr.  A  offers  and  wants  respect- 

123 


CHAPTER  V.      MECHANISM  OF  EXCHANGE 

ively.  This  third  something  Mr.  A  gets  from  Mr.  B  in  exchange 
for  his  own  wood,  and  in  turn  gives  to  Mr.  C  in  exchange 
for  the  latter's  harness. 

Doubtless  the  earliest  form  of  mediated  exchange  was  one 
in  which  the  third  factor  or  medium  of  exchange  was  some  real 
use — commodity ;  i.  e.,  some  commodity  which  'most  people 
wanted  for  some  use  to  which  it  could  be  put  directly,  as,  for 
example,  cattle,  hides,  lumps  of  salt,  cubes  of  tea.  But  quite 
early  people  got  in  the  way  of  more  or  less  completely  devoting 
some  one  thing  to  this  office  exclusively, — setting  up  some  one 
thing  as  the  regular,  conventional,  medium  of  exchange,  which 
people  would  rarely  put  to  any  other  use.  Such  a  specialised 
medium  of  exchange  is  called  money;  and  a  system  of  exchange 
employing  such  a  medium  is  money-exchange. 

The  preceding  discussion,  in  bringing  out  the  nature  of 
money-exchange,  has  also  of  necessity  brought  out  the  primary 
function  of  money, — to  act  as  the  official  medium  of  exchange. 
A  second  function,  which  naturally  attaches  itself  to  the  official 
medium  of  exchange  and  is  in  some  connections  almost  as  im- 
portant, is  to  act  as  the  generally  used  measure  of  values,  that 
is,  the  thing  in  which  the  values  of  goods  are  computed  and 
expressed. 

Analysis  of  a  Typical  Monetary  System. 
(See  Reading  X.) 

In  the  beginnings  of  money-exchange,  the  money  used  was 
little  more  than  official  ingots  of  one  or  more  precious  metals. 
But  with  the  evolution  of  an  elaborate  commercial  order,  the 
primitive  money  has  developed  into  a  complicated  system  con- 
sisting of  several  different  kinds  of  money  each  adapted  to 
a  special  sort  of  work,  but  all  embodying  a  common  unit  and 
based  upon  a  common  standard. 

The  first  thing  to  be  noted  in  such  a  monetary  system  is  the 
unit  or  principal  denomination  and  the  subordinate  denomina- 
tions related  to  the  unit  as  multiples  or  fractional  parts  thereof. 
In  our  system,  the  unit  is  a  dollar ;  subordinate  denominations 
arc  the  cent,  dime,  half-eagle,  eagle,  and  double  eagle.  In 
Great  Britain,  the  unit  is  a  pound  or  sovereign ;  in  France, 
a  franc;  in  Germany,  a  mark;  in  Russia,  a  rouble;  and  so  on. 

Next  after  the  different  denominations  of  a  monetary  sys- 
tem comes  the  standard,  which  is  properly  defined  as  that  which 

129 


PRINCIPLES  OF  ECONOMICS 

fixes  the  value  of  the  unit.  In  the  United  States,  the  ultimate 
standard  is  a  lump  of  gold  weighing  23.22  grains  pure  or  25.8 
grains  when  alloyed.  Whatever  value  such  a  lump  of  gold  has, 
the  dollar  also  has.  If  the  value  of  the  lump  goes  up,  so  also 
does  that  of  the  dollar.  The  relation  of  the  monetary  standard 
to  the  system  is  closely  analogous  to  that  of  the  standard  of 
liquid  measure  to  that  system.  That  is,  just  as  8.33  pounds  of 
pure  water  determines  what  shall  be  the  volume  of  a  gallon 
measure,  so  25.8  grains  of  gold  determines  what  shall  be  the 
value  of  a  dollar. 

The  monetary  stock — the  actual  money — consists  of  standard 
money  and  several  subordinate  moneys.  Standard  money  is  the 
kind  which  immediately  fixes  the  value  of  the  unit,  and  in  terms 
of  which  other  moneys  are  reckoned.  In  a  typical  modern  sys- 
tem, its  most  distinctive  marks  are  the  legal  prerogatives  of  free 
coinage  and  full  tender  for  debts.  The  chief  subordinate  moneys 
are,  in  our  system,  legal  tender  treasury  notes,  bank  notes, 
silver  dollars  and  their  certificates,  and  subsidiary  coin — frac- 
tional silver,  nickels,  and  coppers. 

The  legal  tender  treasury  notes  are  a  quasi-standard  money, 
i.  e.,  they  do  more  or  less  fully  the  work  of  standard  money. 
Without  them  all  institutions  needing  to  keep  reserves  of  money 
to  pay  demand  obligations  would  have  to  keep  standard  money 
for  this  purpose.  As  it  is,  such  reserves  largely  consist  of  these 
treasury  notes  (in  England,  Bank  of  England  notes). 

Bank  notes,  silver  dollars,  silver  certificates,  and  subsidiary 
coin  constitute  the  major  part  of  the  ordinary  circulating  money, 
the  money  actually,  directly,  used  in  the  conduct  of  business. 
Subsidiary  coin  has  the  following  characteristics:  (1)  being 
made  of  metal  different  from  that  which  is  the  standard,  (2) 
being  short  in  weight,  (3)  having  its  coinage  limited,  (4)  hav- 
ing its  legal  tender  limited,  and  (5)  being  redeemable.  The 
first  characteristic  is  necessary  to  secure  convenience  in  size; 
the  second,  to  keep  this  kind  of  coin  from  being  melted;  the 
third,  to  keep  it  at  par;  the  fourth,  to  hinder  it  from  displacing 
the  standard  and  to  shut  out  forcing  excessive  quantities  of  it 
on  creditors;  and  the  fifth,  to  relieve  the  public  of  any  excess, 
as  also  still  further  to  insure  the  parity  of  this  kind  of  money. 

The  silver  dollar  is  more  or  less  of  an  anomaly  in  our  sys- 
tem, having  full  legal  tender  but  not  being  freely  coined.  In 
•effect,  it  acts  as  a  subsidiary  coin  of  large  denomination. 

130 


CHAPTER  V.   MECHANISM  OF  EXCHANGE 

ILLUSTRATVE  PROBLEMS. 

1.  Illustrate  with  concrete  examples  the  drawbacks  of  barter 
as  a  method  of  exchange. 

2.  Illustrate  the  use  of  money  as  a  measure  of  value  in  a 
case  of  barter. 

3.  In    primitive   communities   the    media    of    exchange   have 
usually   been    objects    desired    for    direct   use   and   also    objects 
commonly   produced  in   the  community.     Give   some   reason   or 
reasons  for  each  of  these  facts. 

4.  During  the  first  part   of  our  history  as   a   nation,  silver 
fractional  coins  had  the  prerogatives   of  standard  money,  i.  e., 
were  freely  coined  and  had  the  status  of  full  legal  tender.     But 
in  1853  Congress  deemed  it  necessary  to  put  this  kind  of  money 
into  the  position  of  subsidiary  coin.     How  dp  you  explain  the 
fact  that   Congress   got   around   to   this   opinion   at   about   that 
particular  time? 

5.  Between  1890  and  1896  it  was  a  common  practice  to  put 
into  notes  and  mortgages  a  clause  providing  for  payment  in  gold 
coin  of  legal  weight  and  fineness.     Try  to  get  the  proper  ex- 
planation of  this  fact 

6.  When  I  say  that  12.9  grains  of  gold  .9  fine  is  the  mone- 
tary standard  of  the  Philippines,  what  is  meant? 

7.  In  the   United   States   in   the  year   1868,  when  gold  pay- 
ments on  treasury  notes  were  suspended  so  that  a  gold  dollar 
was    commonly    worth    from    $1.20    to    $1.40,    one    of    the   great 
political    parties    proposed    to    pay    the    national    debt    in    these 
irredeemable  treasury  notes, — which  proposal,  however,  was  de- 
feated in  the  Federal  election   of  that  year.     In   discussing  the 
matter,  writers  commonly  speak  as  if  the  national  creditors  ob- 
jected to  being  paid  in  treasury  notes  rather  than  gold;  whereas 
no  one  of  them  probably  would  have  thought  of  asking  for  literal 
gold  money.     Explain  in  scientific  language  what  was  the  pre- 
cise issue  of  the  controversy. 

Section   B.     Credit   Exchange. 

In  the  preceding  discussion  it  has  been  assumed  that,  even 
under  modern  conditions,  practically  all  exchange  is  money- 
exchange  in  the  sense  that  money  actually  changes  hands  in 
every  transaction.  But  of  course  the  student  is  aware  that 
this  is  not  the  case.  Almost  all  payments  outside  our  own  place 
of  residence  are  made  by  means  of  documents,  usually  orders 
to  pay  money  issued  by  the  postoffice,  by  banks,  or  by  express 
companies.  Even  within  our  own  community,  a  large  number 
of  payments  are  effected  by  orders  commonly  called  checks.  If 
these  orders  were  immediately  presented  for  cash,  the  transaction 

131 


PRINCIPLES  OF  ECONOMICS 

would  really  be  one  in  which  money  was  actually  used,  only  the 
payment  would  be  effected  through  an  agent  rather  than  by  the 
debtor  himself.  But  commonly,  as  we  all  know,  the  person 
receiving  the  check,  instead  of  getting  cash  with  it,  presents  it 
for  deposit,  so  that  the  transaction  is  consummated  without  an)' 
use  of  money,  by  a  mere  transfer  of  credit  from  the  account 
of  the  payer  to  the  account  of  the  receiver.  This  brings  up  a 
modification  of  money  exchange  which  is  of  great  importance 
in  most  English-speaking  countries  and  which  might  be  called 
credit  money  exchange  or,  more  shortly,  credit  exchange. 

1.    Analysis  of  Credit-Exchange. 

The  real  nature  of  credit  exchange  can  most  easily  be 
brought  out  by  beginning  with  the  case  of  credit  exchange  be- 
tween two  persons  only, — book  credit,  as  it  is  commonly  called. 
Where  there  is  reciprocal  buying  between  two  persons  at  the 
same  time,  it  is  obviously  needless  for  each  to  deliver  the  pay- 
ment money.  The  natural  procedure,  plainly,  is  to  compute  the 
balance  of  the  mutual  obligations  and  have  that  balance  paid 
by  the  one  against  whom  it  falls.  If  the  two  traders  can  trust 
each  other,  it  is  plain  that  a  similar  procedure  is  possible  in  the 
case  of  mutual  purchases  made  at  different  times;  for  each  can 
sell  to  the  other  without  getting  his  pay,  or  by  receiving  as  pay 
the  right  to  claim  money  later,  and  at  some  future  time  the 
reciprocal  obligations  or  debts  thus  created  can  be  cancelled  as 
far  as  possible  and  only  the  balance  actually  paid,  just  in  the 
case  of  simultaneous  purchases.  In  this  simple  case,  we  have 
the  essential  feature  of  credit-exchange,  i.  e.,  bringing  about  in 
some  way  a  reciprocity  of  debts  so  that  a  considerable  cancella- 
tion is  possible  and  only  a  balance  has  to  be  paid  in  actual 
money. 

In  the  case  just  used  to  bring  out  the  nature  of  credit-ex- 
change, i.  e.,  book-credit,  we  have  reciprocal  buying  between  two 
persons,  where  reciprocity,  and  so  possible  cancellation,  are 
assured.  But  there  are  comparatively  few  cases  of  this  sort. 
Most  of  the  buying  of  any  one  of  us  is  from  a  set  of  persons 
quite  different  from  those  to  whom  he  sells.  In  this  case,  how- 
ever, a  true  reciprocity  of  debts  exists  between  any  one  and  all 
the  rest  taken  together.  If  Mr.  A.  could  in  some  way  set  what 
he  owes  everyone  over  against  what  everyone  owes  him,  a  prac- 
tically complete  cancellation  would  be  possible.  This  will  prob- 

132 


CHAPTER  V.   MECHANISM  OF  EXCHANGE 

ably  never  be  feasible.  But  the  idea  can  be  utilized  within  con- 
siderable limits.  For  example,  it  can  be  applied  in  the  exchange 
relation  of  a  man  and  his  immediate  neighbors.  Mr.  A  may 
not  sell  anything  to  that  particular  one  of  his  neighbors  from 
whom  he  has  bought  something;  but  he  will  almost  certainly 
sell  to  some  of  those  neighbors.  As  an  offset  to  the  claims  of 
them,  taken  as  a  whole,  against  him,  he  can  almost  certainly 
bring  forward  claims  in  his  favor  against  them,  taken  as  a 
whole.  If,  then,  we  can  arrange  in  some  way  to  have  all  or 
many  of  the  debts  of  a  man  to  his  neighbors  pooled,  lumped  to- 
gether, and  all  of  their  debts  to  him  pooled,  cancellation,  and  so 
a  great  saving  in  the  money  needed,  can  easily  be  brought  about. 
One  of  the  most  effective  ways  of  doing  this  is  to  make  some 
single  institution  a  sort  of  common  debtor  and  creditor,  which 
institution  then  keeps  effecting  settlements  with  each  of  its  pa- 
trons as  itself  the  representative  of  all  the  rest.  An  example  of 
this  particular  case  is  furnished  by  one  of  the  most  important 
kinds  of  credit-exchange;  viz.,  check-exchange. 

In  the  simplest  form  of  check-exchange,  the  persons  interested 
are  all  depositors  in  a  common  institution  called  a  bank,  i.  e., 
they  keep  their  funds  in  that  institution.  Mr.  A  then  pays  for 
his  purchases  by  giving  to  his  creditors  orders  (checks)  on  the 
bank.  On  the  other  hand,  Mr.  A  receives  pay  from  his  debtors 
in  the  shape  of  checks  on  the  bank,  which  he  in  turn  deposits. 
Thus,  Mr.  A's  transactions  with  his  neighbors  give  rise,  not  to 
money  payments  between  himself  and  them,  but  to  a  set  of 
debits  to  the  bank,  on  the  one  side,  and  a  set  of  credits  by  the 
bank  on  the  other.  Obviously,  these  debits  and  credits  can  be 
cancelled,  as  far  as  they  are  equal,  and  money  payment  needs 
to  be  made  only  for  the  balance.  What  is  true  in  Mr.  A's  case 
is  of  course  just  as  true  in  that  of  his  neighbors,  as  respects  their 
relation  both  to  his  transactions  and  to  any  others  which  may 
arise.  Thus,  by  working  through  a  common  agent  who  acts  as 
the  universal  debtor  and  creditor,  each  is  able  to  set  his  claim 
on  all  the  rest  over  against  his  obligations  to  all  the  rest  and  so 
establish  the  reciprocity,  and  thus  effect  the  cancellation,  which 
make  the  essence  of  credit-exchange. 

In  the  preceding  case  we  have  supposed  that  Mr.  A  and  his 
neighbors  keep  accounts  with  the  same  bank.  But  much  more 
generally  there  are  several  banks  in  the  one  place  and  Mr.  A  has 
many  transactions  with  the  patrons  of  banks  other  than  his  own. 

133 


PRINCIPLES  OF  ECONOMICS 

At  first  sight,  this  seems  to  involve  a  return  to  cash  exchange, 
since  a  check  on  one  bank  deposited  with  another  will  not  be 
debited  to  the  former  bank  for  any  length  of  time,  but  will  be 
presented  for  cash  within  24  hours  anyhow.  In  fact,  however, 
the  bank  which  is  debtor  because  of  the  supposed  transaction 
will  doubtless  have  come  into  possession  of  checks  on  the  creditor 
bank  which  it  can  use  to  offset  the  claim  against  itself.  Even  if 
it  has  no  claims  against  that  particular  bank,  it  will  certainly 
have  some  against  some  of  the  others ;  and,  as  the  banks  will 
settle  their  mutual  obligations  on  a  pooling  plan,  these  claims 
against  other  banks  will  do  just  as  well  as  claims  against  its 
creditor  in  offsetting  its  debits. 

The  last  sentence  brings  us  to  another  very  important  develop- 
ment of  credit-exchange,  viz.,  the  clearing,  the  settlement  of 
mutual  obligations  among  a  number  of  different  banks.  Here 
the  same  device  which  enables  Mr.  A.  to  settle  his  debits  and 
credits  with  a  minimum  use  of  money,  viz.,  fixing  things  so  that 
he  is  paired  off  against  all  other  persons  at  once,  is  applied  to 
settle  the  mutual  obligations  of  banks.  In  general,  the  plan  is 
to  set  up  a  common  agent,  a  clearing-house  association,  with 
which  each  bank  settles, — that  association  becoming  the  creditor 
of  each  bank  for  all  claims  of  all  other  banks  against  that  bank 
and  becoming  its  debtor  for  all  its  claims  against  all  other  banks. 
A  balance  is  then  struck  and  whichever  proves  to  be  debtor,  the 
bank  or  the  clearing-house,  pays  the  balance.  Naturally,  the 
clearing-house  settles  first  with  the  banks  which  prove  to  be 
debtors,  and  then  uses  the  money  thus  obtained  to  settle  with 
the  creditor  banks. 

The  last  two  paragraphs  have  had  to  do  with  check  credit- 
exchange.  Another  and  much  older  form  is  inter-local  credit- 
exchange,  or  what  is  called  Exchange  in  the  preeminent  sense. 
This  is  the  form  of  credit-exchange  which  is  used  to  effect  pay- 
ment between  different  cities  and  countries  with  a  minimum  use 
of  money.  Here  we  have  the  same  old  device:  claims  for  and 
against  different  countries,  debits  and  credits,  get  into  common 
hands  so  that  reciprocity  is  established  and  cancellation  is  made 
possible.  In  practice,  certain  institutions  in  each  country,  banks 
or  exchange  houses,  buy  up  all  the  claims  on  other  countries  and 
also  sell  for  the  use  of  their  patrons  claims  on  those  other 
countries.  Thus,  they  become  the  common  creditors  and  the  com- 
mon debtors  of  the  dealers  of  their  country  in  its  relations  to 

134 


CHAPTER  V.   MECHANISM  OF  EXCHANGE 

other  countries;  and  the  debit  and  credit  relations  which  they 
maintain  with  other  countries  are  maintained  with  institutions 
similar  to  themselves.  It,  therefore,  becomes  easy  to  set  the 
debits  of  a  country  over  against  its  credits,  cancel  these  in  so 
far  as  they  are  equal,  and  effect  a  complete  settlement  by  paying 
a  small  balance  in  money. 

2.     Instruments  of  Credit-Exchange. 

A  side  of  credit-exchange  to  which  we  must  give  a  moment's 
attention  has  to  do  with  the  instruments  of  exchange, — the 
papers,  documents,  used  in  effecting  credit-exchanges.  Nearly 
all  of  these  are  orders  for. the  payment  of  money,  made  by  one 
person,  called  the  drawer,  upon  another  person  called  the  drawee, 
in  favor  of  a  third  person  (usually),  called  the  payee.  Property 
in  such  orders  is  transfered  from  one  person  to  another  by 
indorsement,  i.  e.,  by  writing  across  the  back  the  name  of  the 
payee  or  present  owner,  with  or  without  some  specific  directions 
as  to  payment. 

(1)  The  most  familiar  credit  instrument  is  the  bank  check 
which  has  already  been  mentioned.     It  is  an  order  for  the  pay- 
ment of  money  drawn  by  a  depositor  on  his  bank.     It  is  used 
chiefly  at  home,  i.  e.,  within  the  town  where  the  drawee  bank  is 
located. 

(2)  One    of   the    most   important    instruments    of    interlocal 
exchange  is  the  bank  draft.     This  is  an  order  for  the  payment 
of  money  drawn  by  one  bank  on  a   bank  in  another  place,  in 
favor  of  another  party.    A  bank  draft  is  used  when  the  initiative 
is    taken   by   the    debtor.      He    buys    the    draft,    mails    it   to    his 
creditor,  who  gets  cash  or  credit  for  it  from  his  bank,  which,  if 
not  itself  the  drawee  bank,  proceeds  to  collect  from  the  latter. 

(3)  A   third    class    of    exchange    instruments    are    so-called 
money  orders, — postal  or  express  orders.     These  are  drawn  by 
local    agents    of   the    institution    issuing   them   upon    the    central 
office,  are  sold  to  the  debtor,  sent  by  him  to  his  creditor,  who 
collects  from  the  agent  of  the  issuing  institution  located  in  his 
town. 

(4)  When  the  initiative  in  settling  a  transaction  is  taken  by 
the  seller  or  creditor,  the  instrument  employed  is  most  exactly 
named  a  bill  of  exchange,  though  this  phrase  is  also  often  applied 
to  international  bank  drafts.    Such  a  bill  of  exchange,  also  called 
a    commercial    draft,    is    an    order    for    the    payment    of    money 

135 


PRINCIPLES  OF  ECONOMICS 

drawn  by  a  seller  or  creditor  upon  his  debtor  in  favor  of  the 
drawer  or  his  banker.  (If  in  favor  of  himself,  he  endorses  it 
over  to  his  banker.)  When  this  method  of  settlement  is  used 
the  creditor  turns  the  draft  over  to  his  banker  and  gets  credit 
for  the  proceeds,  whereupon  the  banker  sets  out  to  collect  from 
the  drawee  through  banking  correspondents. 

3.     The  Rate  of  Exchange. 

Another  matter  of  much  importance  in  connection  with  credit- 
exchange  is  the  rate  of  exchange,  particularly  the  rate  in 
foreign  exchange.  As  we  have  just  learned,  money  payments  be- 
tween the  people  of  different  communities  are  effected  through 
agents  in  each  community  who  assume  the  position  of  common 
creditor  and  common  debtor  for  that  community.  In  other 
words,  these  persons  buy  up  money  claims  on  other  communities 
from  any  persons  having  such  claims  to  dispose  of,  and  sell 
money  claims  on  other  communities  to  any  persons  who  may 
need  them  to  make  payments  in  those  other  communities.  Thus, 
there  is  developed  a  traffic  in  such  money  claims — a  traffic  in 
"exchange,"  as  such  money  claims  are  commonly  named.  The 
price  at  which  exchange  sells — at  least  in  the  case  of  exchange 
between  different  countries — is  called  the  rate  of  exchange. 
Stated  more  formally:  the  rate  of  exchange  is  the  price  in  one 
country  paid  in  the  money  of  that  country  for  the  right  to  dis- 
pose of  a  unit  of  the  money  of  some  other  country  in  that  other 
country,  or  at  least  in  some  country  other  than  the  one  in  which 
the  purchase  is  made.  Thus,  if  I  wish  to  buy  from  my  bank 
the  right  to  have  five  pounds  sterling  paid  on  my  behalf  in 
London,  and  find  myself  obliged  to  pay  for  that  right  $4.87  per 
pound,  I  say  that  the  rate  of  exchange  on  London  is  $4.87. 

In  domestic  exchange,  i.e.,  exchange  between  different  parts 
of  the  same  country,  the  rate  of  exchange  usually  means  the 
difference  between  the  face  value  of  an  instrument  of  exchange 
and  what  is  paid  for  it.  Thus,  if  I  say  that  the  Chicago  rate 
of  exchange  on  New  York  is  15  cents  premium  per  thousand,  I 
mean  that,  in  selling  a  claim  for  $1,000  on  New  York,  a  Chicago 
dealer  would  get  his  $1,000  and  fifteen  cents  extra. 

In  working  out  the  price  or  rate  of  exchange,  the  market 
naturally  starts  with  the  natural  value  of  the  unit  of  the  money 
wanted,  as  measured  in  the  money  with  which  it  is  bought — i.e., 
the  value  of  the  money  wanted  as  it  would  be  if  there  were  no 

13G 


CHAPTER  V.   MECHANISM  OF  EXCHANGE 

difference  of  place,  if  the  buyer  of  English  money  bought  it 
right  in  New  York  to  be  delivered  in  New  York.  If  the  two 
countries  have  the  same  standard,  say  gold,  then  the  natural 
value  of  either  money  in  terms  of  the  other  can  be  ascertained 
by  a  simple  operation  in  division.  Thus,  one  dollar  contains 
23.22  grains  of  fine  gold ;  and  the  English  pound,  113  grains. 
The  pound,  therefore,  is  naturally  worth  in  our  money  as  many 
dollars  as  23.22  is  contained  in  113,  i.e.,  $4.866.  This  natural 
price  of  a  foreign  money  unit,  measured  in  terms  of  the  home 
money,  is  technically  known  as  the  par  of  exchange. 

The  rate  of  exchange  varies  above  or  below  the  par  of  ex- 
change according  as  the  demand  for  exchange  at  par  is  in  excess 
of  the  supply  or  vice  versa.  If  we  are  selling  great  quantities  of 
cotton,  wheat,  etc.,  to  the  people  of  Europe  and  buying  compara- 
tively little  from  them,  then  claims  on  Europe  will  be  abundant 
and,  other  things  being  equal,  cheap.  That  is,  those  of  us  who 
have  claims  on  Europe  to  sell  will  be  obliged  to  sell  them  cheap, 
while  those  of  us  that  need  to  buy  such  claims  can  get  them 
cheap.  On  the  other  hand,  if  we  are  buying  many  goods  from 
the  people  of  Europe  and  selling  them  comparatively  few,  then 
claims  on  Europe  will  be  scarce  and,  other  things  being  equal, 
dear.  That  is,  those  of  us  who  have  claims  on  Europe  to  sell 
can  get  high  prices,  while  those  who  need  to  buy  such  claims 
will  have  to  pay  high  prices. 

These  variations  of  the  rate  of  exchange  above  and  below 
par  are  limited  by  the  cost  to  exchange  houses  of  transporting 
the  money  ieself  from  the  one  place  to  the  other, — it  being 
understood  that  cost  includes  a  profit  to  the  exchange  dealer. 
The  variations  from  par  can  not  be  greater  than  this,  because 
any  wider  range  would  give  exceptional  profit  to  the  exchange 
dealers,  which  would  stimulate  their  competition,  and  so  re- 
duce the  difference  to  this  amount.  In  the  case  of  London  ex- 
change, the  possible  variation  from  par  is  commonly  in  the 
neighborhood  of  three  cents,  i.e.,  the  rate  ranges  from  about 
$4.835  to  $4.895. 

4.     The  Commercial  Bank. 

In  the  preceding  discussion  of  credit-exchange  it  has  been 
necessary  to  make  repeated  mention  of  banks,  because  of  the 
large  part  in  the  conduct  of  credit-exchange  which  is  played 
by  these  institutions.  The  particular  type  of  bank  here  involved 

137 


PRINCIPLES  OF  ECONOMICS 

— the  bank  in  the  strict  sense  as  understood  by  English  and 
American  writers — may  be  described,  in  general,  as  an  insti- 
tution which  acts  as  common  treasurer  or  fiscal  agent  for  such 
part  of  the  general  public  as  choose  to  patronize  it.  As  such 
common  treasurer,  it  cares  for  the  money  of  its  patrons,  makes 
and  receives  payments  on  their  behalf,  makes  advances  of  money 
to  them,  etc.  Its  functions,  more  formally  enumerated,  are  as 
follows : 

(1)  Receiving  deposits  of  current  funds — funds  which  the 
depositor    expects    to    employ    in    his    current     business — active 
funds.     (Commercial    banks,   to    a   greater    or    less    extent,   get 
deposits  of  idle  funds;  but  this  is  not  their  distinctive  business. 
Such  funds  more  naturally  go  to  savings  banks.) 

(2)  Discount.     Making  short  time  money  loans  to  patrons 
on  the  discount  plan. 

(3)  Check-exchange.    Honoring   the    checks    drawn   by    de- 
positors and  accepting  for  credit  or  payment  checks  drawn  in 
favor  of  depositors. 

(4)  Exchange.     Buying  and  selling  rights  to  claim  money  in 
other  places. 

In  addition  to  these,  the  most  characteristic  functions  of 
banks,  banks  also  collect  debts  for  their  patrons  in  outside 
places.  Still  again,  one  or  more  banks  in  most  countries  make 
a  business  of  issuing  circulating  notes.  Finally,  many  banks  do 
more  or  less  business  in  the  way  of  safety-deposit. 

ILLUSTRATIVE  PROBLEMS. 

1.  Suppose  that  you  send  a  check  on  the  National  Bank  of 
Ann  Arbor  to  the   Newcomb-Endicott  Company  of   Detroit  to 
pay    for   some   goods   purchased ;    and    suppose   that   when    the 
check  finally  gets  back  to  you  it  shows  the  following  endorse- 
ments:      (1)   Pay  to  the  Peninsular   Savings   Bank  of   Detroit, 
the  Newcomb-Endicott  Company.     (2)    Pay  to  the  State  Savings 
Bank  of  Ann  Arbor,  Peninsular  Savings  Bank  of  Detroit.     (3) 
Paid  through  the  Clearing  House,  State  Savings  Bank  of  Ann 
Arbor.    Trace  the  course  of  this  check  from  the  endorsements. 

2.  Henry   T.    Crouch    of    Erie   buys    $1,275    worth    of   wheat 
from  T.   C.   Craig  of   Detroit. 

(a)  Suppose  settlement  to  be  effected  with  a  wheat  bill  of 
exchange    (also   called   a   sight   draft)    and   write   out  the   sub- 
stance  of  the  bill  which  would  be  used. 

(b)  Suppose  settlement  to  be  made  with  a  check  and  write 
out  a  facsimile  (in  substance). 

(c)  Suppose  settlement  to  be  made  with  a  bank  draft  and 
write  out  a  facsimile  (in  substance). 

138 


CHAPTER  V.  MECHANISM  OF  EXCHANGE 

3.  Whichever  method  of  settling  the  transaction  involved  in 
the  last  problem  is  used,  the  particular  credit  document  employed 
will  inevitably  take  quite  a  journey  from  bank  to  bank  while  it 
is  being  collected. 

(a)  Describe    an    imaginary    course    which    it    would    very 
likely  take  if  it  were  a  sight  bill  of  exchange. 

(b)  Same,  if  it  were  a  check. 

(c)  Same,  if  it  were  a  bank  draft.     (Compare  Problem  1.) 

4.  We  buy  a  good  deal  from  Brazil,  but  sell  her  little.     We 
sell  a  great  deal  to  Great  Britain,  but  buy  from  her  much  less. 
Can  you  imagine  a  way  in  which  one  of  these  trades  furnishes 
a  medium  of  exchange  for  the  other? 

5.  Oct.  1,  1907,  the  different  banks  of  Ann  Arbor  brought 
to    the    clearing   claims    against   each     of   the    other   banks    as 
follows : 

No.  1  against         No.  2  against         No.  3  against 


No.  2  $2213.19 

No.  1  $4284.78 

No.  1  $4974.66 

No.  3  1865.09 

No.  3   2172.45 

No.  2  1607.79 

No.  4  2415.96 

No.  4   3043.18 

No.  4  1093.24 

No.  5   512.21 

No.  5   655.87 

No.  5   625.88 

Total  $7006.45        Total  $10156.28        Total  $8301.57 


No.  4  against 

No.  5  against 

No.  1  $3078.73 
No.  2  1793.16 
No.  3  973.73 
No.  5  4633.96 

No.  1  $332.15 
No.  2  377.17 
No.  3  1515.46 
No.  4  181.56 

Total  $10479.58        Total  $2406.34 
Compute  the  balance  for  or  against  each  bank. 

6.  Supposing  all  the  claims  of  the  Ann  Arbor  banks  on  one 
another  which  appear  in  the  last  problem  to  have  consisted  of 
checks  which  were  used  in  the  regular  course  of  business  trans- 
actions ; 

(a)  What  must  have  been  the  total  volume,  expressed  in 
money,  of  the  transactions  thus  effected? 

(b)  How  much  actual  cash  was  needed  to  effect  these  trans- 
actions ? 

(c)  What  per  cent  of  the  total  volume  of  transactions  did 
this  cash  amount  to? 

(d)  What  is  the  significance  of  these  facts? 

7.  Not  many  years  ago  it  was  estimated  that  the  per  capita 
money  circulation  of  England  was  about  $11  while  that  of  France 
was  about  $51 ;  yet,  as  every  one  knows,  there  was  at  least  as 
much  business  per  capita  carried  on  in  England  as  in  France. 
How  could  the  difference  in  the  amounts  of  circulating  medium 
required  be  explained? 

8.  Some    writers    represent    the    development    of    credit-ex- 
change as  a  return  to  barter.     Show  that  this  is  not  true — that 

139 


PRINCIPLES  OF  ECONOMICS 

credit-exchange  is  still  mediated  exchange,  nay  more,  that  it  is 
money   exchange. 

9.  Suppose  I  wish  to  buy  a  bank  draft  for  £200  on  London. 
With    London    exchange    at   $4.855,    what    should    I   be    able    to 
get  the  draft  for? 

10.  A   wheat    exporter   of   New   York   draws    a   bill    on   his 
London  customer  for  £1375.     What  should  he  be  able  to  get  for 
this   bill   with  London  exchange  selling  at  $4.87?   with  London 
exchange  at  $4.84? 

11.  Suppose  that   a   New   York   importer  can  get   50   gross 
of  Sheffield  razors   delivered  in  New   York  for  44  pence  each 
(the  duty  included),  and  that  he  can  sell  them  for  95  cents  each. 
What  would  be  his  profit  on  such  a  transaction  if  the  rate  of 
exchange  on  London  were  $4.84?  if  the  rate  were  $4.87? 

12.  From    the    last   two   problems    what    principles    can    you 
deduce  as  to  the  effect  which  a  high  or  low  rate  of  exchange 
tends  to  have  on  exports?  on  imports? 

13.  "The   greater  part    of   our   circulating   medium   consists, 
not  of  money,  but  of  deposit  currency."     Explain  what  is  meant 
by   deposit   currency. 

14.  Near  what  point  would  you  expect  the  rate  of  exchange 
on  Europe  to  be  found  in  the  fall  of  the  year?     Why? 

15.  "A  matter  very  frequently   overlooked  by  the  public  is 
that  a  large   share  of  the  bank  deposits   of  a  country   like  the 
United   States   grow   out   of   loans   and   so   do   not   add  to   the 
cash  holdings  of  the  banks."      Explain  how  this  is  so. 

16.  When  exchange  on  London  is  at  $4.895  or  thereabouts,  it 
is  said  to  be  at  the  upper  gold  point;  and  when  in  the  neighbor- 
hood of  $4.835,  it  is  said  to  be  at  the  lower  gold  point.    Why 
are  these  called  gold  points? 


140 


CHAPTER  VI. 

SOME  ELEMENTARY  PROPOSITIONS  WITH  RESPECT 
TO    MONEY. 

It  is  much  too  early  in  our  study  of  economic  principles  to  at- 
tempt anything  resembling  a  thorough  treatment  of  the  theory 
of  money.  Nevertheless,  it  is  important  to  set  forth  at  the  very 
outset  of  our  work  some  propositions  bearing  on  this  topic 
which,  though  little  more  than  truisms,  are  yet  frequently  over- 
looked by  the  public,  with  the  result  that  fooJsh  errors  gain 
acceptance  and  lead  to  hurtful  legislation. 

/.  Money  is  simply  one  particular  kind  among  many  kinds 
of  wealth. 

For  a  variety  of  reasons,  we  very  naturally  look  on  money 
as  wealth  par  excellence.  Thus,  money,  being  the  kind  of 
wealth  which  will  procure  for  us  all  other  kinds,  naturally  pre- 
sents itself  to  us  as  the  most  efficient,  and  so  the  most  de- 
sirable, form  of  wealth.  For  the  same  reason,  it  is  readily 
conceived  as  the  typical,  representative,  form  of  wealth,  the 
one  which  stands  for  all  others.  Again,  money  being  the  con- 
ventional measure  of  value,  we  very  naturally  express  wealth 
in  terms  in  money.  .For  example,  we  say  that  "Smith  has  in- 
herited a  half  million  of  dollars,"  meaning  that  he  has  in- 
herited wealth  of  various  kinds  valued  at  a  half  million  dollars. 
But,  while  these  facts  make  it  natural  for  us  to  look  on  money 
as  wealth  par  excellence,  they  surely  do  not  justify  us  in  con- 
ceiving money  to  be  the  only  form  of  wealth.  Nevertheless, 
in  earlier  centuries  whole  communities  have  seemed  at  least  to 
entertain  such  an  idea ;  and,  even  in  our  own  day,  a  few  people 
come  dangerously  close  to  taking  the  same  position.  It  seems 
best,  therefore,  to  give  as  our  first  proposition  in  the  theory 
of  money  "the  correct  dctrine  on  this  matter. 

2.  Money  is  simply  one  among  many  kinds  of  capital  {capi- 
tal goods),  i.e.,  products  which  are  wanted,  not  for  their  own 
sakes,  but  for  the  sake  of  other  things  which  we  can  get  through 

141 


PRINCIPLES  OF  ECONOMICS 

them;  and,  relatively,  money  forms  a  rather  small  portion  of  the 
total  capital  of  the  community. 

Money  as  an  instrument  which  is  employed  by  people  to 
facilitate  the  exchange  of  goods,  to  accumulate  stores  of  capital, 
to  transfer  values,  etc.,  is  of  course  capital,  just  as  truly  as  are 
buildings,  engines,  machinery,  etc.  But  there  are  many  people 
whom  this  degree  of  recognition  for  money  does  not  satisfy. 
Just  as  certain  peculiarities  about  this  institution  mislead  care- 
less persons  into  thinking  of  it  as  the  only  true  wealth,  so  these, 
or  other,  peculiarities  lead  many  persons  to  think  and  talk  as  if 
money  were  the  only  true  capital.  Perhaps  the  peculiarities 
which  most  strongly  work  for  this  result  are  the  following:  (l) 
the  immediate  form  in  which  capital  is  accumulated  is  commonly 
money  or  bank  credit,  and  (2)  all  forms  of  capital,  like  all  forms 
of  wealth  in  general,  are  computed,  expressed,  in  terms  of 
money;  e.g.,  we  say  that  Mr.  Craig  has  $200,000  of  capital  in  the 
milling  business,  meaning  that  he  has  buildings,  a  dam,  races, 
machinery,  etc.,  devoted  to  producing  flour,  which  have  a  value 
measured  in  money  of  $200,000. 

That  the  second  peculiarity  named  does  not  justify  us  in 
conceiving  money  to  be  the  only  true  form  of  capital  is  too  evi- 
dent to  need  argument,  though  it  will  be  a  long  time  before  the 
business  world  rids  itself  of  the  notion  that  somehow  the  money 
which  buys  the  buildings,  machinery,  etc.,  is  the  real  capital 
rather  than  the  buildings,  etc.,  themselves. 

The  other  fact  which  tends  to  make  people  look  on  money  as 
the  only  true  form  of  capital — that  it  is  the  form  in  which  most 
capital  is  accumulated — seems  to  make  the  error  somewhat  more 
plausible,  since  all  (nearly  all)  capital  is  sometime  or  other  in 
this  embodiment.  But,  really,  the  case  is  no  better  than  before. 
The  money  stage  of  capital  is  only  a  momentary  one, — only 
a  transition  form.  Still  more,  it  is  only  the  representative  form 
of  capital,  the  shadow  or  image  not  the  substance.  While  the 
capitalist  is  accumulating  stores  of  money  or  bank  credit,  other 
men  are  manufacturing  lumber,  engines,  machines,  etc.,  practi- 
cally, if  not  literally,  to  the  order  of  our  capitalist;  and  these 
other  things  for  which  the  capitalist,  or  some  one  who  borrows 
his  money,  exchanges  his  store  of  money  or  bank  credit,  con- 
stitute in  the  main  the  real,  final,  form  of  capital 

3.    Money  is  simply  one  particular  kind  of  useful  instrument 
142 


CHAPTER  VI.     MONETARY  TRUISMS. 

of  which  our  stock  should  be  large  enough  to  do  the  money  work 
needing  to  be  done  as  well  as  we  can  afford  to  have  it  done,  but 
of  which  we  do  not  want  more  than  enough  any  more  than  we 
want  more  than  enough  of  chairs,  clothes,  stoves,  engines,  or  any 
other  useful  article. 

Every  time  we  spend  any  of  our  resources  producing  chairs 
we  have  so  much  less  resources  for  producing  food,  fuel,  clothes, 
etc.  If  we  are  sensible,  therefore,  we  will  stop  producing  chairs 
just  as  soon  as  our  need  for  chairs  is  satisfied  as  fully  as  we 
can  afford  to  have  it  satisfied,  in  view  of  our  need  for  food, 
clothes,  etc.  The  case  of  money  is  no  different.  We  want  our 
need  for  money  satisfied  to  the  same  degree  as  our  other  needs ; 
but  we  do  not  want,  and  can  not  afford,  anything  more  than  this. 

4.  Broadly  speaking,  it  is  of  the  very  nature  of  money  to  cir- 
culate (m  person  or  by  proxy},  that  is,  to  pass  from  one  person 
to  another  in  purchase  of  goods  or  to  be  held  awaiting  the  occa- 
sion for  such  use. 

This  proposition  when  understood  must  present  itself  to  our 
minds  as  a  mere  truism.  But  various  widely  accepted  fallacies 
indicate  that  it  is  constantly  overlooked.  "Putting  money  into 
circulation"  is,  with  very  many  minds,  an  action  so  advantageous 
to  society  that  it  covers  a  multitude  of  sins  against  the  general 
welfare.  Thus,  a  government  may  be  wasting  the  substance  of  an 
industrious  people,  carrying  on  a  foolish  and  costly  war.  When 
economists  complain,  some  one  promptly  answers  that  it  is  good 
for  trade  because  it  "puts  money  in  circulation."  Of  course,  the 
answer  is  easy.  The  money  would  be  in-  circulation  anyhow. 
That  is  its  business.  If  the  government  did  not  take  it  from 
the  owners  by  taxation  or  borrowing,  those  owners  would  them- 
selves be  spending  it  on  the  good  things  of  life,  or  on  engines, 
machinery,  mills,  and  other  forms  of  capital. 

5.  Broadly  speaking,  it  is   of  the  very  nature   of  money  to 
remain  money — not  to  be  consumed  in  the  sense  of  being  finally 
absorbed  into  the  life  of  any  individual.     It  follows  that  the  fact 
that  the  stock  of  money  is  unchanged  proves  nothing  as  to  how 
the  amount  of  wealth  or  capital  is  affected  by  particular  lines  of 
conduct. 

This,  again,  is  a  truism  which  needs  only  to  be  understood  to 
be  accepted   and  yet  is   constantly   overlooked   by   many  people. 


PRINCIPLES  OF  ECONOMICS 

If  we  complain  of  the  foolish  squandering  of  a  great  capital  by 
a  worthless  heir,  people  at  once  say :  "I  don't  see  that  any  harm 
is  done.  The  money  spent  by  the  foolish  heir  is  still  here.  It 
has  only  been  transferred  to  better  hands."  Of  course  the 
money  is  here.  Money  is  nothing  but  a  counter,  a  check  so  to 
speak  calling  for  goods,  a  shuttle  of  exchange  flying  back  and 
forth,  helping  different  producers  to  effect  the  exchanging  of 
their  goods.  But,  while  the  money  is  here  just  as  it  would  have 
been  anyhow,  something  else  is  not  here  that  would  have  been, 
had  the  foolish  son  followed  in  the  steps  of  his  father.  That 
something  is  productive  goods,  engines,  cars,  bridges,  shops, — 
something  which  would  continue  for  years  to  give  off  uses,  and 
which  could  have  been  produced  by  the  same  labor  which  was 
expended  in  ministering  to  the  young  man's  follies.  Society  as 
a  whole  is  vastly  poorer  than  it  would  have  been,  though  the 
quantity  of  money  is  just  the  same. 

6.  It  is  of  the  very  nature  of  money  to  go  back  and  forth 
between  communities,  to  move  like  a  shuttle  out  and  in;  trade 
with  the  outside  zuorld  does  not  of  itself  tend  to  take  away  our 
money. 

The  world  outside  our  city  or  country  wants  our  money  in 
exchange  for  their  goods  (assuming  that  they  do  really  de- 
mand it),  not  to  keep  for  eating  or  wearing  or  warming  houses 
or  any  other  use  which  involves  retaining  possession  of  it,  but 
to  send  it  back  to  purchase  our  goods. 

ILLUSTRATIVE  PROBLEMS. 

1;  "Foreign  trade  can  add  to  the  national  wealth  only  when  it 
brings  in  a  money  balance." 

(a)  What  is  the  principal  thing  to  be  gained  by  maintain- 
ing trade  relations  with  the  outside  world? 

(b)  When   would   it   be  of   advantage  to   have   our   foreign 
trade  bring  in  a  money  balance? 

2.  "A  nation  is  so  much  poorer  by  every  dollar  it  sends  out, 
just   as   an   individual    is    so   much   poorer   by   every   dollar   he 
spends."     Criticise  both  clauses. 

3.  "Everything  we   buy  abroad   takes   just   so   much   money 
out  of  the  country." 

Show  that  this  can  not  be  true  whether  it  is  meant  that  such 
buying  abroad  takes  the  money  out  immediately  or  only  ulti- 
mately. 

4.  Suppose   that   official    reports    from    all    the   banks    of   a 
certain   city   show  that,   on   an  average,  93   per  cent   of  the   de- 

144 


CHAPTER  VI.     MONETARY  TRUISMS. 

posits  received  during  a  certain  day  consisted  of  checks,  only  7 
per  cent  being  in  the  form  of  money.  What  important  fact  with 
respect  to  the  conduct  of  business  in  that  city  would  be  thereby 
disclosed? 

5.  "It  is  sometimes  asked  whether  the  raising  of  a  govern- 
ment loan  to  cover  ordinary  expenditures   really  causes  capital 
to  be  lost,  since  the  coins  received  by  the  government  remain  in 
existence, — even  remain  in  the  country.     This  objection  has  no 
weight   whatever'9 — Pierson's    Principles    of   Economics.      Show 
that  the  statement  in  italics  is  correct. 

6.  "We  pay  110  million  dollars  per  annum  for  the  carrying 
of  products   between   this   and   foreign   countries.     Think  of   it. 
One  hundred  and  ten  million  dollars  in  gold  coin  has  gone  out, 
of  the   commerce    of  this   country   into   the   commerce   of  other 
countries.      Can   New   York   stand   this?" — James    G.    Elaine   in 
1881. 

(a)  Is  it  likely  that  we  permanently  lost  110  million  dollars 
in   gold    from   our    circulation   because   we    hired   foreigners   to 
carry  our  goods? 

(b)  Is  it  likely  that  we  even  temporarily  parted  with  that 
much  gold  on  that  account? 

(c)  Is  it  likely  that  as  a  nation  we  should  have  been  richer  if 
we  had  done  this  carrying  of  products  for  ourselves? 

7.  "I  don't  see  that  society  as  a  whole  loses  anything  by  the 
giving  of  a  fireworks  exhibition  costing  $1,000.     Of  course  the 
people  who  pay  for  the  fireworks  are  just  so  much  out.     But 
then  the  $1,000  goes  to  the  other  people  who  furnish  the   fire- 
works; so  that  society  as  a  whole  comes  out  even."    Criticise. 

8.  Bills   drawn   against   these   heavy   shipments    (of  cotton) 
flooded  the  foreign  exchange  market  this  week  (Nov.  19,  1903), 
depressing  it  to  the  lowest  level  since  Nov.,  1900." 

According  to  popular  ideas,  what  result  ought  to  have  fol- 
lowed the  heavy  shipments  of  cotton  referred  to? 

9.  "My  numerous  armies  promote  the  circulation  of  money, 
and  disburse  impartially  among  the  provinces  the  taxes  paid  by 
the  people  of  the  state." — Frederick  the  Great  justifying  his  wars 
in  a  letter  to  D'Alembert.     (Quoted  from  Bullock.) 

Was  there  anything  in  the  facts  stated  to  offset  the  sacrifices 
undergone  by  the  people  in  paying  the  taxes? 

10.  "The  summer  boarders  are  a  great  blessing  to  our  little 
village;  because  they  put  into  circulation  a  lot  of  money,  which 
means  at  least  temporary  prosperity." 

What  must  we  understand  this  phrase,  "put  into  circulation 
money"  to  mean,  if  we  accept  the  above  as  anything  like  an  ade- 
quate explanation  of  the  prosperity  brought  by  the  summer 
boarders? 

11.  "The  individual  can  get  rich  only  by  selling  more  than  he 

145 


PRINCIPLES  OF  ECONOMICS 

buys   and   saving  the   surplus   in   the   form   of   money   or   bank- 
credit.     So  a  country  can  increase  its  wealth  only  by  exporting 
more  than  it  imports,  and  taking  the  difference  in  money.'' 
Discuss  both  parts. 

12.  "I  am  not  convinced  of  the  soundness  of  the  orthodox 
doctrine  that  a  country  can   have   all   the   money  it   wants   and 
needs,  just  as  it  can  have  all  the  engines,  machinery,  etc.,  which 
it  wants.     Money  is  very  different  from  other  things.     It  would 
be  easy  to  give  a  man  all  the  food  and  clothes  he  wants ;  but, 
however  much  money  you   offered  him,   he   would  take   it  all 
gladly." 

Criticise. 

13.  From  a   Salt  Lake  supporter  of  the  "Seeing  America" 
movement:     "We  recognize  that  Americans  are  annually  spend- 
ing $200,000,000  in  foreign  travel.    That  practically  every  dollar 
of  this  vast  sum  is  lost  to  the  home  circulation  can  not  be  dis- 
puted." 

Criticise  the  last  sentence. 


146 


CHAPTER  VII. 
CERTAIN  FUNDAMENTAL  PRINCIPLES  OF  TRADE. 

The  preceding  chapter  brought  out  certain  elementary  proposi- 
tions with  respect  to  money  which,  though  little  more  than  tru- 
isms, are  yet  often  overlooked  and  so  need  to  be  remarked  upon. 
For  trade  or  exchange  in  general,  there  are  similar  elementary 
propositions — perhaps  a  little  more  removed  from  the  status  of 
truisms  though  certainly  simple  enough — which  are  also  con- 
stantly overlooked  and  so  deserve  comment.  The  most  funda- 
mental one  of  these  has  already  been  given  on  page  18  in  the 
principle  that  the  chief  function  of  exchange  is  to  make  co- 
operation and  specialization  possible.  We  must  now  add  two 
others  scarcely  less  fundamental  or  important. 

Section  I.     Say's  Law. 

The  first  of  these  principles  has  to  do  with  the  conditions 
which  determine  the  total  demand  for  goods.  Demand,  as 
understood  by  the  economist,  means  the  quantity  of  any  goods 
which  buyers  actually  stand  ready  to  take,  as  conditions  are, 
including  the  existing  price.  Demand  in  this  sense  obviously 
implies  the  existence  of  desire  on  the  part  of  buyers,  coupled 
with  power  to  buy, — control  of  some  adequate  equivalent  to  be 
exchanged  for  the  thing  purchased.  Now,  it  is  plain  that  every 
producer  will  naturally  be  anxious  to  see  the  demand  for  his 
particular  product  become  as  large  as  possible.  In  order  to 
promote  this  desirable  result,  he  probably  tries  to  make  his 
product  particularly  good, — anyhow  expends  much  effort  seek- 
ing to  convince  buyers  of  its  goodness.  But  he  is  seldom 
content  with  this.  He  wishes  to  enlist  the  conscious  support  of 
his  neighbors  and  fellow  citizens  acting  in  their  personal 
capacity  or  through  public  legislation.  For  example,  he  tries  to 
get  the  .rich  in  the  way  of  spending  their  money  liberally,  or  he 
urges  the  government  to  raise  money  by  taxation  and  undertake 
expensive  improvements.  But  it  is  manifest  that,  in  order  to 
enlist  the  support  of  producers  generally  in  any  scheme  which 

147 


CHAPTER  VII.    PRINCIPLES  OF  TRADE 

a  particular  producer  may  propose  for  helping  matters,  he  must 
be  able  to  show  that  said  scheme  will  be  of  advantage  to  others 
as  well  as  to  himself.  The  usual  way  of  doing  this  is  to  argue 
that  the  proposed  scheme  will  increase  demand  for  goods  in  gen- 
eral. Hence  there  arise  even  under  primitive  trade  conditions 
various  doctrines  as  to  how  general  demand — total  demand — is 
determined.  These  doctrines  are  nearly  all  erroneous;  so  that  a 
presentation  of  sound  principles  is  of  much  importance. 

Principle.      Say's    Law.     The   Ultimate  -Identity   of   Demand 

and  Product. 

In  the  last  analysis,  the  demand  for  goods  produced  for  the 
market  consists  of  goods  produced  for  the  market,  i.e.,  the  same 
goods  are  at  once  the  demand  for  goods  and  the  supply  of 
goods;  so  that,  if  we  can  assume  that  producers  have  directed 
production  in  true  accord  with  one  another's  wants,  total  de- 
mand must  in  the  long  run  coincide  with  the  total  product  or 
output  of  goods  produced  for  the  market. 

Proof  :     First  Hypothesis — Trade  takes  the  form  of  barter. 

(1)  Demand  cannot  include  anything  outside  of  product — 
output;   for  no  one  can  demand  goods  except  by  offering  other 
goods  in  exchange,  and  such  goods  must  have  been  produced. 

(2)  Demand  must  include  all  of  the  goods  produced  for  the 
market ;  for  such  goods  will  surely  be  offered  in  exchange,  else 
they   would   not  have  been  produced,   and,   in   being   offered   in 
exchange,  they  constitute  each  a  demand  for  other  goods. 

(3)  But,  if  demand  can  not  include  anything  outside  of  prod- 
ucts and  must  include  all   of  these,  then  demand  and  products 
must  coincide. 

Second  Hypothesis — Trade  carried  on  with  money. 
Here  demand  is  immediately  determined  by  the  amount  of 
money  controlled  by  buyers.  But,  obviously,  buyers  can  get 
money  only  by  producing  it  or  by  getting  it  in  exchange  for 
something  else  which  has  been  produced.  That  is,  in  the  last 
analysis,  in  money-exchange  as  in  barter-exchange,  the  things 
really  exchanged  are  products;  so  that  the  case  of  money-ex- 
change is,  from  our  present  point  of  view,  substantially  the  same 
as  that  of  barter-exchange,  and  therefore  is  covered  under  the 
preceding  hypothesis. 

Notes:  (1)  The  proviso  which  appears  in  the  second  clause 
of  the  principle, — "assuming  that  all  producers  direct  their  pro- 
duction in  true  accord  with  one  another's  wants" — is  necessary; 

148 


CHAPTER    VII.    PRINCIPLES    OF    TRADE. 

since,  if  any  producer  should  find  that  the  particular  goods  he 
wanted  were  not  offered  for  sale,  he  might  decide  to  leave  the 
exchange  operation  half  completed, — selling  his  goods  for  money 
or  credit  but  not  using  that  money  or  credit  to  buy  other  goods. 
(2)  This  last  must  not  be  understood  to  imply  that  exchange 
is  never  complete  unless  the  money  received  for  goods  sold  is 
in  turn  used  to  buy  other  goods.  In  a  few  cases,  the  money 
which  the  seller  gets  for  his  goods  is  the  ultimate  thing  he 
wants.  For  example,  he  may  wish  to  get  gold  to  use  in  making 
jewelry  and  may  choose  to  do  this  by  melting  coins ;  or  he  may 
have  a  fad  for  collecting  gold  coin  just  as  another  man  might 
collect  old  pictures ;  and  so  on. 

ILLUSTRATIVE  PROBLEMS. 

1.  "The    destruction   of   property   has   one   compensation    in 
that  it  increases  the  demand  for  commodities  or  services  and  so 
makes  trade  good." 

Explain  the  fallacy.     (See  Reading  XII,  C.) 

2.  "George  Rankin  is  of  course  a  big  fool  to   spend  $400 
making  a  mill  dam  in  a  creek  which  is  dried  up  every  summer 
and  never  has  enough  water  to  run  an  ice  cream  freezer ;  but 
he  is   doing  one  good  thing, — he  is  making  a  whole  lot  more 
demand  for  labor  and  so  a  lot  more  employment  for  laborers." 

Explain  fallacy. 

3.  "There  is  just  so  much  work  to  be  done.    The  entrance  of 
women  and  children  into  the  field  of  labor  must  drive  out  an 
equal  amount  of  adult  male  labor." 

Criticise.  (There  are  no  doubt  objections  of  real  weight  to 
the  extension  of  child  and  female  labor;  but  this  is  not  one  of 
them.) 

4.  "The  real  cause  of  the  present  standstill  in  trade  is  the 
inequality  of  incomes.     There  can  be  no  effective  demand,   be- 
cause those  who   have   the  money   to   buy  have   no   unsatisfied 
wants,  while  those  who  have  the  wants  have  no  power  to  buy." 

Criticise. 

5.  In  a  certain  part  of  a  recent  novel,  Mr.  Blossom,  a  young 
painter  and  decorator,  is  trying  to  induce  Miss  Cynthia  to  give 
him  a  job  re-decorating  her  house,  which  is  somewhat  behind 
the  times  in  this  respect.    The  latter  part  of  the  conversation  on 
the  matter  is  as  follows: 

"  'Live  and  let  live'  is  a  good  enough  motto  for  me." 
"  'Live   and   let   live/ "   repeated   Miss   Cynthia,   thoughtfully. 
"What  do  you  think  that  means?" 

"Why,  it's  plain  enough,"  said  Mr.  Blossom,  strongly. 
"You're  living  all  right,  ain't  you?  Got  enough  of  everything 
and  something  to  spare  .  .  .  ;  but  you've  got  to  let  other 
folks  live.  ...  If  there's  anything  you  want  done  that  you 
can't  do  for  yourself,  hire  somebody  that  can  do  it  .  .  .  , 
so  they  can  live,  too.  If  everybody  did  that  right  along,  I 

140 


PRINCIPLES  OF  ECONOMICS 

guess  there  wouldn't  be  so  much  ta!k  about  labor  unions  ami 
strikes  and  all  that  sort  of  thing." 

(a)  Would  Miss   Cynthia's   deciding  to   spend   and  actually 
spending  $600  to  re-decorate  her  house  increase  the  employment 
of  laborers  generally? 

(b)  Why  can  we  be  certain  that  everybody  is  now  doing  the 
thing  which  Mr.  Blossom  thinks  they  ought  to  be  doing? 

6.  Street  comment  on  a  cold   snap   which   bursts  numerous 
water-pipes :     "Hard  on  householders,  sure  enough ;  but  no  great 
loss  without  some  small  gain.     It's  a  bonanza   for   Ann   Arbor 
plumbers."     Is   that   sound? 

7.  Mr.  A,  having  earned  and  saved  $10,000,  buries  it  in  the 
ground.     Another,  having  earned   and   saved   $10,000,   spends    it 
on  a  great  banquet.     Which  makes  the  greater  demand  for  prod- 
ucts? 

Explain. 

8.  Would  we  naturally  expect  events  like  the  San  Francisco 
earthquake  and  fire  to  increase  the  demand  for  labor  in  general? 

Explain. 

9.  "It  is  of  course  natural  and,  from  the  standpoint  of  cer- 
tain individuals  immediately  interested,  desirable  that  the  mem- 
bers   of  the   Methodist    Church   or   the    Baptist    Church    or    any 
other  such  like  organization  should  give  their  custom  to  dealers 
who   are   members   of   their    own    organization.      But,    from    the 
general  economic  standpoint,  the  presumption  is  against  the  desir- 
ableness  of   all   such   interference   with   the   natural   working   of 
things." 

Give  some  reasons   for  this  opinion. 

10.  "Economically   it   is    for   the   interest    of   every   class    of 
producers   to    see    the    efficiency    of    other    classes    of    producers 
increase." 

Why? 

11.  During  the  last  fifteen  years,  the  Western  nations  have 
laid  much  stress  on  making  and  keeping  the  Chinese  trade  open 
to  all;  and  not  a  few  have  anticipated  from  the  policy  a  great 
expansion   in   the   market   for    our   products.      Show   that    Say's 
law  suggests  a  reason  for  looking  on  such  anticipations  as  rather 
ill-founded. 

12.  "Every  true  friend  of  labor  must  condemn  without   re- 
serve all  prison  systems  which  devote  convict  labor  to  the  pro- 
duction of  goods  for  the  market.     Every  such  system  must,  in 
the  nature  of  the  case,  increase  the  supply  of  commodities  with- 
out increasing  the   demand,   and   so   must  diminish   the   employ- 
ment available  for  honest  laborers  who  keep  out  of  prison." 

Show  in  detail   (not  by  citing  the  principle)   that  the  demand 
for  goods  is  increased  by  convict  labor  as  much  as  the  supply. 

13.  "The     extraordinary     advance     in     industrial    technique 

150 


CHAPTER    VII.     PRINCIPLES    OF    TRADE. 

characteristic  of  the  last  half  century  has  so  increased  our  pro- 
ductive capacity  that,  when  things  are  running  smoothly,  output 
is  bound,  sooner  or  later,  to  exceed  demand,  which  condition 
of  things  invariably  leads  to  a  commercial  crisis  followed  by  a 
general  collapse  of  industry." 

Criticise. 

14.  "The  true  way  to  insure  industry  against  general  over- 
production is  to  raise  the  rate  of  wages  all  along  the  line,  thus 
increasing  the  buying  power  of  the  masses  and  therefore  caus- 
ing consumption  to  overtake  production." 

Criticise. 

15. The  Chicago  Record-Herald  for  April  18,  1908,  contained 
the  report  of  an  interview  with  the  head  of  one  of  America's 
great  universities,  wherein  various  opinions  and  statements  were 
attributed  to  King  Haakon  of  Norway.  Among  these  was  the 
following :  "I  could  black  my  own  boots  if  I  wished  to ;  I  have 
done  it  and  therefore  know  how ;  but  if  I  did,  what  would  be- 
come of  the  people  who  make  a  living  blacking  boots?" 

Criticise  on  the  basis  of  Say's  law. 

Section  II.    The  Principle  of  Reciprocity. 

If  a  man  were  told  that  he  could  get  no  good  out  of  trade 
with  his  fellows  unless  he  bought  as  well  as  sold, — that  trade, 
as  respects  individuals  anyhow,  is  necessarily  reciprocal, — he 
would  perhaps  be  quite  impatient  at  being  taken  for  a  person 
so  stupid  as  to  need  instruction  in  such  truisms.  But,  when 
any  question  of  trade  between  communities  arises,  this  very 
same  man  will  probably  show  himself  quite  oblivious  to  the 
principle  which  seems  so  evident  in  domestic  trade.  Thus,  he 
will  very  likely  consider  it  entirely  possible,  as  well  as  highly 
desirable,  to  increase  the  volume  of  goods  sold  to  other  coun- 
tries while  leaving  stationary  the  quantity  bought.  Or  he  will 
bemoan  the  importation  of  goods  from  outside  as  decreasing 
demand  for  home  goods,  quite  overlooking  the  fact  that  the 
goods  imported  must  be  paid  for  with  others  exported  and  there- 
fore must  mean  an  increased  outside  demand  for  home  goods. 
It  is  therefore  necessary  for  us  to  set  forth  in  quite  definite  and 
formal  shape  the  almost  self-evident  truth  that  trade  between 
communities,  as  well  as  between  individuals,  must  be  reciprocal. 

Principle.     The  Principle  of  Reciprocity. 

Exchange  between  communities,  as  between  individuals,  is 
necessarily  reciprocal;  and,  speaking  broadly,  the  total  of  goods 
(not  including  money)  sold  by  any  community  to  all  other  com- 
munities must  in  the  long  run  equal  the  total  of  goods  (not  in- 

151 


PRINCIPLES  OF  ECONOMICS 

eluding  money)  bought  by  that  community  from  all  others,  save 
that  there  will  'usually  tend  to  be  a  slight  excess  of  goods  ex- 
ports from  communities  not  producing  standard  money  "-""tal 
and  a  more  or  less  considerable  excess  of  goods  imports  into  a 
country  producing  standard  money  metal, — it  being  assumed 
that  the  distribution  of  population  among  different  communities 
remains  substantially  unchanged  during  the  period  tinder  con- 
sideration. 

Comments:  (1)  The  meaning  of  the  principle  is  most  easily 
brought  out  by  applications.  In  introducing  the  discussion,  we 
inevitably  suggested  some  of  these.  Thus,  the  principle  is  in- 
tended- to  tell  us  that  no  one  can  reasonably  hope  to  increase  the 
volume  of  goods  sold  by  his  community  without  also  increasing 
the  volume  bought,  and  vice  versa.  So,  it  can  not  reasonably 
be  charged  that  by  buying  goods  outside  we  lower  the  demand 
for  home  goods  and  so  the  opportunities  for  employment  at 
home;  for  the  goods  bought  outside  must  be  paid  for  by  goods 
produced  at  home,  which  means  employment  producing  them. 
Again,  it  is  not  reasonable  to  fear  that  buying  outside  will  cause 
an  export  of  our  money — unless  we  are  producers  of  money 
metal;  for,  supposing  the  quantity  of  money  to  be  constant, 
goods  exports  and  goods  imports  must  tend  to  be  equal. 

(2)  The   student    should    note   that   the    Principle    of   Reci- 
procity does   not  tell  us  that  the   goods   sold  by  the  people  of 
one  country  to  the  people  of  another  country  must  equal  the 
goods  bought  by  the  former  from  the  latter.     It  only  says  that 
the  goods  sold  to  all  countries  must  equal  the  goods  bought  from 
all  countries.     Taking  our   stand   with   any   one   nation,   all   its 
exports  must  equal  all  its  imports. 

(3)  The  Principle  of  Reciprocity  must  not  be  understood  as 
teaching  that  the  exports  of  a  country  as  reported  by  the  cus- 
toms authorities  must  equal  the  imports  as  reported  by  the  same 
authorities.     In   fact,  these  two   sums   are   rarely  if   ever   equal, 
though  the  total  products   sold — exports — must   substantially   al- 
ways be  equal  to  the  total  products  bought — imports.     The  ex- 
planation of  this  seeming  paradox  is  easy.     Customs  reports  do 
not,    and    can    not,    show   all   exports    and   imports.      Thus,    the 
true  imports  of  a  country  obviously  include  everything  bought 
by  its  people  from  the  people  of  other  countries.     But  some  of 
these  things  bought  from  other  countries  can  not,  or  at  least  do 
not,  come  to  the  knowledge  of  government   officials.     Of  these 
the  most  important  are  (1)  goods  and  services  bought  from  the 
foreigner  in  his  own  country,  e.g.,  by  pur  people  traveling  there, 
and  (2)  services  bought  from  the  foreigner  and  delivered  in  our 
own  country,  but  not  appearing  in  import  lists  because  as  serv- 
ices they  do  not  go  through  the  custom  house.     In  short,  there 
are  invisible,  as  well  as  visible,   imports ;   and   it  is  the  sum  of 
both  of  these  which  must  be  equal  to  the  total  of  exports.  What 

152 


CHAPTER    VII.     PRINCIPLES    OF    TRADE. 

has  been  said  of  imports  applies  of  course  to  exports.  Of  these 
seme  are  visible,  some  invisible;  and  it  is  their  sum  which  must 
equal  the  total  imports. 

Accordingly,  if  we  wish  to  get  a  correct  balance  sheet  of  the 
exports  and  imports  of  a  country;  we  must  add  to  the  figures 
furnished  us  by  the  customs  officials,  figures  from  other  sources 
— mostly  mere  estimates — taking  into  account  these  invisible 
exports  and  imports.  Thus,  if  it  is  true,  as  some  say,  that  we 
get  transportation  done  for  us  by  other  nations  to  the  value  of 
$200,000,000  per  year,  we  must  enter  on  the  import  side  of  the 
balance  sheet  an  item  like  this : 

Services  of  carriers $200,000,000 

So,  if  it  is  true  that  we  use  capital  borrowed  from  other  coun- 
tries to  an  amount  which  calls  for  $120,000,000  of  interest  per 
year,  then  we  must  enter  on  the  import  side  this  item: 

Services  of  Borrowed  Capital  $120,000,000 

or,  in  the  more  usual  form: 

Interest  on  Borrowed  Capital •  •  .$120,000,000 

I  hardly  need  add  that  the  countries  selling  us  these  services 
would  have  to  make  similar  entries  on  the  export  side  of  their 
balance  sheets.  (See  Reading  XIV.) 

(4)  It  perhaps  ought  to  be  remarked  that  the  Principle  of 
Reciprocity  above  laid  down  should  not  be  confused  with  the 
policy  of  reciprocity  much  advocated  and  occasionally  practiced 
in  this  country.  The  latter,  as  indicated,  is  a  policy  in  the  con- 
duct of  a  nation's  commercial  relations,  not  a  natural  law  govern- 
ing phenomena.  Further,  as  a  policy,  reciprocity  has  its  chief 
theoretic  basis  in  alleged  natural  laws  which  are  quite  incon- 
sistent with  the  Principle  of  Reciprocity.  Most  advocates  of  the 
policy  of  reciprocity  are  more  or  less  pronounced  disbelievers  in 
the  Principle  of  Reciprocity. 

ARGUMENT   FOR   THE   PRINCIPLE. 

A.  The  total  exports — including  money — must  equal  in  value 
the  total  imports,  assuming  that  no  one  is  cheated.    This  is  sure- 
ly self-evident. 

B.  If  we  suppose  that  this  necessary  equality  of  exports  and 
imports  is  not  secured  by  the  equality  of  goods  exports  and  im- 
ports affirmed  in  the  principle,  then  it  must  be  secured  by  a  net 
export  or  import  of  money.     Now,  the  money  involved  in  such 
a  movement  of  money,  say  an  export,  might  be  (a)   some  part 
of  a  new  output  of  money  metal  from  a  country  producing  such 
metal,  e.g.,  Australia  or  the  United  States,  or  (b)  a  portion  of 
the  stock  of  money  already  in  use  in  the  exporting  country.    But 

153 


PRINCIPLES  OF  ECONOMICS 

the  first  case  is  provided  for  in  the  principle  before  us.  It  only 
remains,  then,  to  show  that,  in  the  long  run,  the  equality  of 
exports  and  imports,  which  is  obviously  necessary,  will  not  be — 
can  not  be — secured  by  export  or  import  from  the  existing  money 
stock.  If  we  increase  our  import  of  goods,  we  must,  broadly 
speaking,  increase  our  export  of  goods,  not  our  export  of 
money ;  and  vice  versa. 

(1)  It  seems  almost  justifiable  to  say  that  this  statement  is 
self-evident.     A  community  could  not  for  long  pay  for  an  ex- 
cess of  imports  by  drawing  on  its   stock  of  money;  since  that 
stock  would  sooner  or  later  become  completely  exhausted  and  so 
trade  would  have  to  cease. 

(2)  But  the  objector  would  probably  declare  that  this  ex- 
haustion of  the  money  stock  is  just  what  he  fears,  and  its  ap- 
pearance, together  with  the  consequent  cessation  of  trade,  would 
decisively    disprove   the    Reciprocity    doctrine.      It,   therefore,    is 
necessary  to   show   that  there  is  no  danger  of  exhausting  the 
money  stock  through  trade  or  even  of  drawing  it  down  to  1m- 
duly  small  proportions. 

(a)  In  the  first  place,  under  normal  conditions,  international 
trade  is  mediated  through  credit  rather  than  through  money, 
and,  under  the  natural  working  of  the  principles  of  credit  ex- 
change, goods  exports  and  goods  imports  tend  to  be  made  equal 
automatically.  The  first  part  of  this  statement  hardly  needs 
comment.  We  have  noted  earlier  that  the  exporter  takes  his 
pay  in  the  shape  of  a  credit  on  other  countries  and  that  these 
credits,  getting  into  the  hands  of  exchange  dealers,  are  as  far 
as  possible  cancelled  and  only  balances  paid  in  money.  Such 
has  always  been  the  practice  and,  for  manifest  reasons  of  con- 
venience, always  will  be.  The  second  part  of  the  statement,  if 
less  familiar,  is  no  less  true.  Under  the  natural  working  of 
credit  exchange,  exports  and  imports  tend  to  be  made  equal 
automatically;  the  balances  which  have  to  be  paid  in  money 
tend  to  disappear  or  to  reach  a  neglible  minimum.  How  this 
comes  about  is  easily  shown. 

As  we  have  already  seen,  the  medium  of  exchange  in  foreign 
trade  is  credit;  and,  in  the  working  of  this  system,  foreign 
credit — exchange — is  bought  and  sold  and  so  has  a  price  known 
as  the  rate  of  exchange.  This  price  will  be  high  in  any  given, 
country  if  importing  into  that  country  is  excessive  and  export- 
ing deficient,  since  this  will  make  the  demand  for  such  exchange 

154 


CHAPTER  VII.    PRINCIPLES  OF  TRADE 

great  and  the  supply  small ;  while,  under  the  opposite  conditions, 
the  price  of  exchange  will  be  low.  But  a  high  price  for  exchange 
will  make  exporting  more,  and  importing  less,  profitable  than 
usual,  while  a  low  price  for  exchange  will  make  exporting  less, 
and  importing  more,  profitable  than  usual.  That  is,  a  high  rate 
of  exchange  will  stimulate  exports  and  discourage  imports,  while 
a  low  rate  will  have  an  opposite  effect.  But  it  was  excess  of 
imports  which  caused  a  high  exchange  rate ;  hence  excess  of 
imports  will  tend  automatically  to  increase  exports  and  diminish 
imports.  So,  it  was  excess  of  exports  which  made  the  exchange 
rate  low; — hence  excess  of  exports  will  tend  automatically  to 
increase  imports  and  diminish  exports.  And  obviously  these 
tendencies  will  persist  in  greater  or  less  power  until  exports  and 
imports  become  equal.  So  long  as  either  buying  from  outsiders 
or  selling  to  outsiders  is  in  excess  of  the  other,  a  rate  of  exchange 
is  bound  to' obtain  which  discourages  the  side  of  trade  which  is 
in  excess  and  stimulates  its  opposite,  with  the  result  that  the  ex- 
cess must  progressively  diminish  and  -finally  disappear.  (See 
Reading  XVI,  B.) 

(b)  The  preceding  argument  has  shown  that  international 
trade  is  normally  carried  on  without  the  use  of  money  and  tends 
automatically  to  balance  itself  without  the  intervention  of  money. 
To  lay  finally  the  ghost  that  foreign  trade  will  drain  away  our 
stock  of  money — to  make  clear  that  the  necessary  equality  of 
exports  and  imports  can  not,  under  normal  conditions,  be  se- 
cured by  exporting  our  stock  of  money  but  must  be  brought 
about  through  increasing  the  export  of  goods — to  do  this  we 
need  to  show  that  any  drain  from  the  normal  money  stock  of  a, 
country  tends  to  be  checked  automatically.  The  demonstration 
is  not  difficult. 

In  the  first  place,  practically  all  the  money  which  is  exported 
from  any  country  in  the  course  of  trade  is  taken  from  the  bank 
reserves  of  the  chief  commercial  and  banking  center, — in  our 
case  New  York,  in  that  of  England  London,  and  so  on.  The 
explanation  of  this  strict  localization  of  a  money  drain  has  al- 
ready been  more  or  less  fully  anticipated.  Trade  with  outside 
people  is,  as  we  remember,  almost  entirely  carried  on  with  credit; 
and  the  international  claims  thus  created  get  into  the  hands  of  a 
few  exchange  houses  in  the  different  countries,  are  as  far  as  pos- 
sible cancelled,  and  the  balances  either  way  paid  in  money.  But 
quite  inevitably  this  dealing  in,  and  settling  of,  international 

155 


PRINCIPLES  OF  ECONOMICS 

credits  is  mostly  confined  to  the  chief  commercial  center  where 
the  large  volume  of  transactions  develop  the  most  efficient  and 
least  expensive  processes  of  settlement.  The  exchange  houses 
of  this  commercial  center  of  course  keep  accounts  with  the 
banks  of  that  center,  or  are  themselves  engaged  in  a  regular 
banking  business.  In  either  case,  the  money  which  they  send 
out  will  be  taken  from  the  banking  reserves  of  the  commercial 
center  and,  more  especially,  from  that  portion  of  the  reserve 
known  as  the  surplus  reserve,  i.e.,  the  portion  which  is  in  excess 
of  the  amount  which  banks  are  by  law  required  to  keep;  since 
this  portion  only  is  so  free  as  to  be  fully  available. 

It  being  recognized  that  a  money  export  is  inevitably  taken 
from  the  banking  reserve  of  the  chief  commercial  and  banking 
center,  a  long  step  has  been  taken  toward  our  goal;  for  the 
banking  reserve  in  question  occupies  a  very  significant  place,  and 
any  considerable  change  in  its  volume  is  likely  to  bring  about 
marked  results.  First,  it  is,  in  a  very  important  sense,  the  re- 
serve, not  only  of  the  city  where  it  is  located,  but  also  of  the 
country  at  large ;  for  the  banks  of  other  cities  keep  from  one- 
half  to  three-fifths  of  their  reserve  in  the  central  city  banks. 
Secondly,  the  reserve  of  the  central  city  is,  in  the  natural  work- 
ing of  things,  kept  down  to  the  lowest  possible  amount, — in 
other  words,  the  money  funds  of  the  center  are  kept  employed 
to  the  limit  of  safety.  This  results  from  the  large  number  and 
scale  of  transactions,  the  enormous  amount  of  speculation,  the 
stupendous  projects  which  have  to  be  financed — provided  with 
ready  money — at  this  center,  and  so  on.  This  excessive  utiliza- 
tion of  the  banking  funds  of  the  central  city  results  in  keeping 
down  the  surplus  or  free  reserve  to  a  very  low  point,  say,  from 
five  to  twenty  millions.  If  business  and  speculation  are  very 
active,  this  surplus  reserve  is  even  likely  to  disappear  altogether 
and  be  turned  into  a  deficit  As  a  result  of  these  peculiarities 
of  the  central  city  reserve,  changes  in  its  amount  are  of  great 
significance,  and  are  carefully,  even  anxiously,  watched  by  the 
business  community  both  of  the  central  city  and  of  the  country 
at  large.  In  particular,  this  central  reserve  has  quite  excep- 
tional significance  in  that  changes  in  its  volume  quickly 
lead  to  opposite  changes  in  the  rate  of  discount,  i.e.,  the  rate 
of  interest  paid  on  bank  loans; — a  change  of  a  few  millions  in 
the  bank  reserve  sometimes  causing  the  rate  on  call  loans  to 
jump  from  two  or  three  per  cent  to  five  or  ten  or  fifteen. 

156 


CHAPTER  VII.    PRINCIPLES  OF  TRADE 

We  are  now  prepared  to  show  how  a  drain  of  money  from 
the  country  tends  to  check  itself.  That  result  is  accomplished 
through  one  or  more  of  several  series  of  reactions  started  by 
the  outflow  of  money  itself.  The  first  series  of  reactions,  and 
the  one  which  works  most  promptly,  is  as  follows :  the  outflow 
of  money  lowers  the  central  city  reserve  to  an  abnormal  point; 
this  raises  the  rate  of  discount ;  the  central  city  becomes  a  more 
than  usually  profitable  place  for  the  investment  of  capital ;  this 
leads  foreign  creditors  to  decide  to  leave  their  money  capital 
here  for  investment  rather  than  having  it  sent  to  them ;  and 
so  the  outward  movement  of  money  tends  to  be  checked. 

If  this  first  series  of  reactions  fails  to  accomplish  the  result, 
there  are  still  a  second  and  third  to  come  in.  The  second  runs 
as  follows :  the  outflow  lowers  the  central  reserve ;  this  raises 
the  rate  of  discount;  a  fall  takes  place  in  the  price  of  securities 
and  of  the  great  staples — such  as  wheat,  cotton,  etc;*  this  fall 
in  prices  stimulates  foreign  buying  of  these  securities  and  staples; 
and  such  buying  tends  to  turn  the  balance  of  international  credit 
in  our  favor  and  so  to  stop  the  outflow  of  money  or  even  to 
cause  an  inflow. 

In  extreme  cases,  a  still  more  powerful  series  of  reactions 
may  be  set  in  operation.  The  outflow  of  money  may  go  so  far 
as  to  cause  a  serious  deficiency  of  money  for  the  purposes  of 
general  trade;  this  would  tend  to  bring  about  a  general  fall  of 
prices;  foreign  buying  of  all  sorts  of  export  goods  would  be 
powerfully  stimulated ;  and  the  favorable  balance  of  credit 
quickly  resulting  would  surely  stop  any  money  outflow. 

Summarizing  the  discussion,  it  is  plain  that  any  considerable 
drain  of  the  ordinary  money  stock  of  a  country  tends  automat- 
ically to  check  itself ;  that,  consequently,  the  necessary  equality 
of  exports  and  imports  can  not  in  the  long  run  be  secured  by 
movements  of  money,  save  in  so  far  as  these  are  movements 
of  new  stocks  of  money  metal;  and,  therefore,  goods  exports 
and  goods  imports  must,  broadly  speaking,  be  equal. 


*This  grows  out  of  the  fact  that  there  is  a  vast  amount  of  speculative 
trading  in  these  securities  and  staples  and  the  further  fact  that  this 
trading  is  largely  based  on  borrowed  capital.  As  a  result,  a  high  rate  of 
discount  hinders  people  from  buying  as  freely  as  otherwise  and  even 
drives  them  to  sell  their  present  holdings, — either  of  which  procedurei 
tends  to  lower  prices. 

157 


PRINCIPLES  OF  ECONOMICS 

ILLUSTRATIVE  PROBLEMS. 

1.  "Another  important  reason  for  keeping  our  fleets  as  far 
as  possible  in  our  own  ports  is  that  under  this  policy  the  money 
they  spend  for  ordinary  supplies  goes  to  our  own  people." 

Explain  what  the  writer  probably  meant  and  criticise  it. 

2.  "To   the   same   extent   that   the   home   market   is   wrested 
from  foreigners  and  given  to  protected  home  producers,  the  for- 
eign  market   is   wrested   from   unprotected   home   producers." — 
Seager,  p.  381. 

Explain  and  defend  the  statement. 

3.  "When  I  came  to  Marblehead  they  had  their  houses  built 
by  country  workmen,  and  their  clothes  made  out  of  town,  and 
supplied   themselves    with   beef   and   pork    from    Boston,   which 
drained  the  town  of  its  money."— Barnard's  Autobiography. 

Criticise  the  part  in  italics. 

4.  From  a  suppositious  editorial  of  a  Benton  Harbor  news- 
paper:    "The  annual  influx  of  students  and  other  outsiders  into 
the  fruit  belt  to  engage  in  fruit  picking  and  packing  is  an  abuse 
which  should  be  stopped  at  once.     These  people  consume  verv 
little,  saving  their  money  to  take  back  to  Ann  Arbor,  Chicago, 
and  the  other  places  from  which  they  came.     Thus,  while  mak- 
ing large  sums  off  us,  they  give  little  or  nothing  to  the  support 
of  our  industries." 

Criticise. 

5.  "One  reason  for  our  almost  constant  excess  of  exports  is 
that   we   are   enterprising   and    so   are   always    opening   up   new 
markets." 

Objector.  "Opening  up  new  markets  might  increase  our  ex- 
ports but  could  not  increase  our  excess  of  exports  unless  some- 
body cheated  us, — seeing  that  our  country  is  one  of  the  chief 
producers  of  gold." 

(a)  Argue  for  the  correctness  of  the  second  quotation. 

(b)  Why  was  the  phrase  from  the  dash,  added? 

6.  Remarks    of    a    leading    Congressman    when    it    was    an- 
nounced  that   the    Canal    Commission    would    purchase    supplies 
wherever  they  could  be  secured  most  cheaply.     "The  President 
should  be  able  to  see  the  desirability  of  purchasing  the  supplies 
in  this  country  alone,  because  thus  employment  would  be  given 
to  American  capital  and  labor  instead  of  foreign." 

Explain  fallacy. 

7.  The  chief  reason  for  our  excess  of  exports  is  to  be  found 
in  the  fact  that  the  things  which  we  sell  are  more  necessary  to 
our  neighbors  than  the  things  which  they  sell  are  to  us." 

Criticise. 

8.  "The  true  way   to  quicken   foreign   demand    (for   British 
goods)  was  to  open  the  ports  to  that  foreign  supply  with  which 

158 


CHAPTER  VII.    PRINCIPLES  OF  TRADE 

they  paid  us  for  what  they  bought  from  us." — Morley's  Glad- 
stone, vol.  i,  p.  267. 

Show  that  the  above   is   sound   doctrine. 

9. "If  we  buy  rails  from  England,  we  get  the  rails  of  course, 
but  they  get  our  money;  while,  if  we  buy  the  rails  at  home,  we 
have  the  rails  and  the  money  too." 

(a)  Is  there  any  reason  to  expect  that  our  buying  rails  in 
England  would  carry  off  our  regular  stock  of  money?    Explain. 

(b)  Substitute   "cotton"  for  "money"  throughout  the  above 
quotation  and  show  the  fallaciousness  of  the  doctrine. 

10.  "The  reason  of  high  exchange  is  the  buying  much  com- 
modities in  any  foreign  country  beyond  the  value  of  what  that 
country  takes  of  ours." — John  Locke. 

Show  that  Locke's  statement  does  not  fully  cover  the  case. 

11.  "The  trade  of  the  United  States  shows  an  excess  of  ex- 
ports,  because  it   is   a  large   resourceful   country   which   has  to 
supply  other  countries  with  raw  materials." 

Criticise. 

12.  "I  have  always  believed  that  free  trade  would  secure  the 
greatest   general   prosperity,  provided   that   all   countries   would 
practice  it.     But,  if  neighboring  countries  are  bound  to  maintain 
protection,  it  is  only  fair  to  ourselves  to  do  the  same." 

(a)  What  is  the  real  economic  evil  of  having  our  neighbors 
shut  out  our  goods? 

(b)  Would  we  better  matters  by  shutting  out  theirs? 

13.  A  Detroit  physician  who  has  a  son  in  the  University  at 
Ann  Arbor  requires  the  latter  to  buy  his  clothes  and  other  sup- 
plies just  as  far  as  possible  in  Detroit,  on  the  ground  that,  since 
bis  income  is  earned  in  that  city,  it  ought  to  be  spent  there. 

(a)  Has  the  father  placed  himself  under  obligations  to  the 
people  of  Detroit  by  earning  an  income  from  them? 

(b)  Supposing    the    distribution    of    population    unchanged, 
would  Detroit  as  a  whole  get  any  more  employment  on  the  one 
plan  than  on  the  other? 

14.  A  Western  newspaper,  anxious  to  hinder  the  people  of 
the  community   from   buying  outside,   represents   a  silver   dollar 
as  appealing  to  a  home  dentist  about  to  send  it  to  Montgomery 
Ward  &  Co.  of  Chicago,  in  the  following  strain : 

"Now,  look  here,  Doc.  If  you'll  only  let  me  stay  in  this 
town  I'll  circulate  around  and  do  you  lots  of  good.  You  buy 
a  big  beefsteak  with  me,  and  the  butcher  will  buy  groceries,  and 
the  grocer  will  buy  dry  goods,  and  the  dry  goods  merchant  will 
pay  his  doctor  bill  with  me,  and  the  doctor  will  spend  me  with 
a  farmer  for  oats  to  feed  his  buggy  horse,  and  the  fanner  will 
buy  fresh  beef  from  the  butcher,  and  the  butcher  will  come 
around  to  you  and  get  his  tooth  mended.  In  the  long  run,  you 
see,  I  will  be  more  useful  to  you  here  at  home  than  if  you 
send  me  away  forever." 

159 


PRINCIPLES  OF  ECONOMICS 

(a)  Clear  up  once  more  the  fundamental  errors  in  all  talk 
of  this  kind. 

(b)  Show  that,  even  if  we  admit  the  principle  implied  in  the 
quotation  (that  only  the  money  spent  at  home  can  complete  the 
circuit  so  as  to  get  back  to  the  original  spender),  only  a  very 
small  portion  of  the  dollar  could  get  back  to  the  dentist. 

15.  English   people   own   much   capital   which   is   earning  in- 
terest or  dividends  in  other  countries.     What  effect   does  this 
fact  tend  to  have  on  England's  exports  or  imports? 

16.  "If  it  were  possible  for  one  county  to  provide  by  law 
or  otherwise  that  no  dollar  which  came  into  it  could  be  sent 
out,  within  two  years  the  county  would  be  so  much  richer  than 
its  neighbors  that  they  would  begin  to  wonder,  etc." — Western 
newspaper. 

(a)  What   do   you   suppose   are   his    reasons    for   expecting 
such  a  policy  to  produce  the  great  prosperity  predicted? 

(b)  Show  that  his  great  expectations  are  unreasonable. 

(c)  Show   that   the   policy   in   question    would   be   likely   to 
make  the  county  poorer  rather  than  richer. 

17.  "You  admit  that  it  would  increase  the  productive  power 
of  a  given  county  to  have  a  man  with  one  hundred  thousand 
dollars  move  in,  bringing  his  money  with  him.     How,  then,  can 
you  deny  that  the  county  would  grow   richer  if  it  could  and 
should   for  three   or  four  years  stop  all   money  which   came  in 
from  going  out?" 

Show  that  we  are  guilty  of  no  inconsistency  in  admitting  the 
one  contention  and  denying  the  other. 

18.  "Exports  tend  to  stimulate  imports,  and  vice  versa." 
Prove  it. 

19.  The  following  was  taken  from  a  country  newspaper  in 
1908:     "It  appears  to  this   paper  that  all  this   severe   criticism 
...     of  Mrs.  Howard  Gould's  requiring  $70,000  a  year  to  pay 
her  expenses  is  quite  uncalled  for.     What's  the  difference,  any- 
way?    If  she  and  her  folks   have  the   'dough,'  let  them  spend 
it  as  fast  as  they  like.     That's  better  than  hoarding  it.     When 
the  money  is  spent  it  goes  to  some  one  and  gets  into  circulation. 
We  people   whom   circumstances   compel  to   live   on   30   cents   a 
day  would  be  glad  to  see  all  the  old  millionaires  spending  each 
$70,000  a  year  on  himself,  or  ten  times  that  amount  if  he  wants 
to.     The  money  isn't  lost." 

(a)  State  clearly  what  advantage  the  writer  of  the  above 
probably  imagined  that  the  public  derive  from  the  extravagance 
of  Mrs.  Gould   and   other   rich  people. 

(b)  Explain  the  fallacy  in  the  doctrine. 

(c)  Show  that  the  last  sentence  of  the  quotation  is  of  no 
significance  in  the  matter. 

20.  "The  so-called  Principle  of  Reciprocity  is  all  rubbish.     It 
is  child's  play  to  show  that  we  can  sell  to  other  countries  even 

160 


CHAPTER   VII.     PRINCIPLES   OF   TRADE 

if  we  do  not  buy  from  those  countries.  No  British  buyer  of 
American  goods  asks  the  question  whether  America  buys  British 
goods.  His  only  question  is :  'Does  this  article  in  character  and 
price  suit  me?'  if  so.  he  buys  it.  Further,  it  is  a  matter  of  com- 
mon knowledge  that  a  country  will  often  buy  a  great  deal 
from  some  other  country,  even  though  it  sells  little  or  nothing 
to  that  other  country.  Thus  Germany  has  no  better  customer 
than  England,  whose  goods  she  keeps  out  by  tariff.  So  we  buy 
largely  from  Brazil,  though  we  sell  her  very  little." 

(a)  State  the  Principle  of  Reciprocity. 

(b)  Show   that   the   arguments    against   this    principle   con- 
tained in  the  above  quotation  have  no  bearing  on  the  case. 

21.  "Our  neglect  of  the  South  American  trade  is  simply 
scandalous.  We  buy  a  large  amount  from  Brazil  every  year 
but  sell  her  almost  nothing,  leaving  her  markets  to  be  gobbled 
up  by  England  and  other  European  countries.  We  ought  to 
subsidize  a  great  merchant  marine  running  to  South  America, 
and  drive  Europe  out  of  a  market  which  is  naturally  ours." 

Show  that  a  very  plausible  argument  can  be  made  for  the 
contention  that  we  should  be  cutting  off  our  own  noses  if  we 
were  to  drive  Europe  out  of  the  markets  of  South  America. 


1G1 


CHAPTER  VIII. 

THE     PRINCIPLES     GOVERNING     THE     IMMEDIATE 
DETERMINATION   OF   PRICES. 

We  have  already  more  than  once  emphasized  the  point  that, 
fin  the  present  economic  order,  exchange  is  the  factor  which 
'effects — makes  possible — the  £O-operation  of  men  in  their  eco- 
nomic efforts  and,  what  is  equally  important,  regulates,  directs, 
that  co-operationx  It  has  also  been  noted  that,  in  this  regulat- 
ing of  co-operation,  the  chief  process  whereby  exchange  ac- 
complishes the  result  is  moving  prices  up  or  down.  For  ex- 
ample, if  too  little  of  any  particular  thing  is  produced,  exchange 
presently  gives  us  a  higher  price,  which  higher  price  makes  the 
producing  of  the  thing  in  question  more  profitable  and  so 
causes  more  to  be  produced.  Again,  exchange  regulates  the 
utilization  of  the  stock  already  in  existence  through  changes  in 
price.  Thus,  if  the  stock  of  any  commodity  is  exceptionally 
small,  the  price  rises,  people  curtail  their  consumption,  and 
thereby  the  abnormally  small  stock  is  made  to  go  around.  Fin- 
ally, exchange  regulates  how  wealth  shall  be  distributed, — how 
much  each  shall  receive  in  wages,  salary,  interest,  profits, 
etc.,  chiefly  by  this  same  process  of  moving  prices  up  or  down. 
From  these  facts  it  is  manifest  that  the  processes  of  price  de- 
termination are,  in  the  present  order,  of  paramount  importance 
a-nd  that  the  natural  laws  which  regulate  these  processes  form 
a  very  vital  part  of  the  science  of  economics. 

For  the  present,  we  shall  confine  our  attention  to  the  prin- 
ciples supposed  to  be  operative  under  complete  freedom  of  com- 
petition and  contract.  Later  we  shall  have  to  comment  briefly 
on  price  making  under  monopoly,  i.e.,  a  state  of  things  wherein 
the  supplying  of  any  commodity  is  practically  under  the  con- 
trol of  a  single  natural  or  legal  person.  Even  in  our  present 
study  it  will  need  to  be  noted  that  competition  and  contract  are 
in  practice  never  completely  free  and  hence  the  principles  to  be  set 
forth  are  never  perfectly  operative.  They  do,  however,  play 
much  the  largest  part  in  actual  price  determination  and  so  must 
be  fully  mastered.  Again,  our  present  study  has  to  do  mainly  with 

162 


CHAPTER  VIII.     SUPPLY  AND   DEMAND 

wholesale,  rather  than  retail,  prices.  The  latter  are  largely 
ignored  in  economic  discussion.  The  principal  reasons  for  this 
are:  (1)  it  may  be  assumed  that  retail  prices  must  tend  to  fol-  ( 
low,  and  in  the  long  run  do  follow  wholesale  prices,  and  (2) 
the  principles  governing  the  variations  from  what  wholesale 
prices  would  lead  us  to  expect  which  actual  retail  prices  show, 
are  too  complicated  and  obscure  to  reward  adequately  their 
serious  study. 

In  making  an  adequate  study  of  the  problem  of  price-determin- 
ation, it  is  almost  indispensable  to  attack  that  problem  at  succes- 
sive levels,  or  strata,  so  to  speak, — in  other  words,  with  successive 
degrees  of  thoroughness.  That  is,  we  find  it  best  to  begin  by 
trying  to  settle  the  more  superficial  phases  of  the  problem;  to 
follow  this  with  ,a  solution  that  goes  into  the  matter  more  deeply ; 
and  then  perhaps  to  finish  with  an  attempt  to  cover  the  whole 
matter  to  the  very  bottom.  In  support  of  this  procedure,  there 
are  at  least  two  good  arguments.  First,  the  deeper  processes  of 
price-determination  are  worked  out  through  more  immediate 
processes  which,  therefore,  need  to  be  studied  first  as  a  prelim- 
inary to  the  analysis  of  the  deeper  processes.  Secondly,  in  deal- 
ing with  different  practical  problems,  the  theoretic  materials 
needed  belong  to  quite  different  levels  or  strata : — for  some  pur- 
poses, only  the  most  superficial  processes  need  to  be  taken  into 
account;  for  other  purposes,  deeper  'processes  must  come  into 
view ;  for  still  other  purposes,  still  deeper  processes ;  and  so  on.* 
The  study  of  price-determination  here  undertaken  will  break 
roughly  into  three  parts:  (i)  the  immediate  processes,  (2)  the 
intermediate  processes, — normal  price,  and  (3)  the  ultimate  prin- 
ciple of  price-determination.  All  such  divisions  are  of  course 
more  or  less  arbitrary;  but  the  one  used  will,  I  think,  justify 
itself  as  we  proceed.  This  chapter,  then,  is  concerned  with 
the  immediate  processes  of  price  determination. 

The  statement  just  made,  that  we  are  to  begin  with  the  im- 
mediate processes  of  price-determination,  needs,  .after  all,  some 
qualification.  One  process  of  price-determination  which  is  prob- 
ably the  most  immediate  of  ail  will  receive  only  mention.  I 
allude  to  bargaining  which  forms,  we  may  assume,  the  most 


*  This  is  not  at  all  peculiar  to  the  field  before  us ;  but  is  common  to 
all  subjects  of  human  knowledge.  Almost  any  person  needs  a  certain 
amount  of  information  with  respect,  to  human  anatomy ;  a  coach  of  athletes 
needs  a  much  larger  amount ;  a  surgeon  can  hardly  afford  less  than  the 
completest  possible  knowledge. 

163 


PRINCIPLES  OF  ECONOMICS 

immediate  of  all  processes  concerned  in  the  determination  of 
prices.  We  mean  by  bargaining  the  forming  of  an  agreement  or 
bargain  between  buyer  and  seller.  In  primitive  economic  socie- 
ties, this  bargaining  plays  a  very  large  part  in  the  fixing  of  actual 
prices ;  and,  even  under  a  more  highly  developed  order,  its  role, 
though  less  significant,  is  still  of  considerable  importance.  But, 
whether  of  importance  or  not,  experience  seems  to  show  that  its 
serious  study  can  not  be  expected  to  yield  scientific  results  of 
sufficient  magnitude  to  repay  the  effort.  It  will,  therefore,  be 
passed  by  in  our  discussion  of  prices. 

Section  A.     Demand, 
i.     The  Nature  of  Demand. 

It  is  a  fact  with  which  almost  every  one  has  some  acquaint- 
ance that,  broadly  speaking,  the  determination  of  price  is  some- 
how a  matter  of  demand  and  supply.  We  naturally,  then,  begin 
with  a  study  of  these  elements — devoting  the  present  section  to 
the  former,  demand.  In  general,  we  shall  understand  by  the 
demand  for  any  particular  commodity  the  quantity  of  that 
commodity  which  buyers  stand  ready  to  take  at  some  specific 
price.  In  this  definition  let  us  emphasize,  first,  the  point  that 
demand  is  the  amount  which  buyers  stand  read}-  to  take, — offer 
to  take.  That  is,  demand  must  not  be  confused  with  (a)  the 
amount  men  want,  on  the  one  hand,  nor  (b)  with  the  amount 
men  actually  buy,  on  the  other.  Demand  must  not  be  confused 
with  the  amount  wanted.  Mere  want,  mere  desire,  not  backed 
by  buying  power  and  not  brought  to  an  issue  in  determination 
to  purchase  if  the  price  is  satisfactory,  does  not  constitute  de- 
mand. The  penniless  man  looking  in  at  the  baker's  window 
however  hungry,  adds  nothing  to  the  demand  for  bread.  But, 
while  men's  needs,  wants,  plans,  do  not  constitute  demand,  they 
plainly  play  a  vital  role  in  determining  demand.  Thus,  if  an 
electric  company  is  intending  to  use  the  water-power  of  the 
Huron  river  on  a  great  scale  for  supplyirg  current  to  De- 
troit and  other  cities,  said  company  will  need  a  large  amount  of 
copper  wire,  and,  so,  will  doubtless  come  on  the  market  to  buy 
such  wire.  That  is,  needs,  plans,  constitute  one  condition  of 
demand.  They  do  not,  however,  constitute  demand  itself.  De- 
mand exists  only  when  the  company  stands  ready  to  buy  the 
wire.  Wre  have  thus  seen  that  it  is  important  not  to  confuse 
demand  with  the  amount  which  people  want  or  need,  it  is  equally 

164 


CHAPTER  VIII.     SUPPLY  AND   DEMAND 

important  to  keep  it  distinct  from  the  amount  actually  bought. 
The  amount  of  demand  and  the  amount  bought  will  often  be 
equal;  but  the  meaning,  the  connotation,  of  the  two  phrases  is 
different.  Further,  this  difference  is  of  much  importance.  The 
amount  which  buyers  stand  ready  to  take  plays  a  very  great  part 
in  determining  price.  But  the  amount  actually  bought  plays  no 
such  part, — in  fact,  is  itself  determined  after  price  is  determined. 

We  have  elaborated  the  point  that,  according  to  our  definition, 
the  demand  for  any  commodity  is  the  amount  of  that  commodity 
which  buyers  stand  ready  to  take.  We  must  emphasize,  secondly, 
the  phrase  "at  some  specific  price."  That  is,  every  proper  state- 
ment affirming  the  existence  of  a  demand  must  explicitly  or  by 
implication  represent  this  demand  as  conditioned  on  a  certain 
price.  Thus,  it  is  proper  to  say  "The  demand  for  silver  at  55 
cents  per  ounce  is  120,000  ounces."  It  is  not  proper  to  say  "The 
demand  for  silver  is  120,000  ounces,"  leaving  out  the  phrase  "at 
55  cents  per  ounce,"  except  on  condition  that  both  the  person 
making  the  remark  and  the  one  to  whom  it  is  addressed  already 
have  one  particular  price  in  mind,  as  for  example,  the  price  at 
which  sales  are  actually  being  made  at  the  time  the  statement 
appears.  The  grounds  on  which  the  above  contention  rests  are 
perhaps  sufficiently  evident.  The  affirmation  that  "the  demand 
for  silver  is  120,000  ounces,"  strictly  interpreted,  ought  to  mean 
that  there  is  a  demand  for  120,000  ounces  of  silver  whatever  be 
the  price.  But,  of  course,  no  such  affirmation  could  reasonably 
be  made.  If  any  person  familiar  with  business  matters  were  to 
make  a  statement  like  the  above,  he  would  doubtless  assume 
that  other  persons  would  understand  him  to  mean  that  the  de- 
mand named  existed  at  the  current  market  price  or  at  some  price 
approximately  equal  to  said  market  price. 

To  the  above  account  of  this  matter,  it  should  be  added  that 
the  relation  between  the  volume  of  demand  and  the  conditioning 
price  is  ttvo-fold.  (i)  A  properly  worded  affirmation  with  re- 
spect to  demand  means  that,  if  price  is  the  one  named,  the  de- 
mand will  be  of  the  volume  indicated.  (2)  Secondly,  it  means 
that,  only  if  price  is  the  one  named,  will  demand  be  of  the 
volume  indicated.  Accordingly,  if  we  say  that  the  demand  for 
silver  is  120,000  ounces  at  55  cents,  we  should  be  understood  as 
affirming  both  the  following  propositions:  (a)  If  any  person 
wishes  to  insure  that  demand  shall  not  get  as  large  as  120,000 
ounces,  he  must  insure  that  price  does  not  go  as  low  as  55  cents. 
Cb)  If  any  person  wishes  to  insure  that  demand  shall  be  as  great 

165 


PRINCIPLES  OF  ECONOMICS 


as   T  20,000  ounces,  he  must  insure  that  price  does  go  as  low  as 
55  cents. 

2.     The  Relation  of  Demand  to  Price. 

In  the  preceding  discussion,  it  was  shown  that  the  quantity 
of  demand  is  conditioned  upon  price.  We  must  now  explain  this 
conditioning  more  fully.  Let  us  suppose  that,  on  a  certain  day, 
the  actual  price  of  silver  proves  to  be,  say,  55c  per  ounce,  and 
that  at  this  price  buyers  offer  to  purchase,  say,  120,000  ounces, 


9   .    .    . 


thus  making  this  amount  the  actual  demand.  This  quantity  ac- 
tually demanded  at  55c  is  represented  in  the  accompanying  dia- 
gram by  the  shaded  portion,  DD',  of  the  broken  rectangle  DD", 
— that  rectangle,  as  a  whole,  being  intended  to  represent  the  in- 
definite volume  of  demand  at  some  price  or  other.  Now,  start- 
ing with  this  hypothesis  of  120,000  ounces  actually  demanded  at 
55c,  we  may  be  quite  sure  that  the  very  same  persons  who  are 
actually  offering  to  buy  120,000  ounces  at  55c,  or,  anyhow,  some 
other  persons,  are  prepared  to  buy, — have  the  mental  attitude 
needed  to  induce  them  to  buy, — say,  10,000  ounces  more  at  a 
price  of  540;  40,000  ounces  more  it  a  pri.^e  of  530;  80,000  ounces 
more  at  a  price  of  52c ;  and  so  on.  That  is,  right  alongside  of 
this  J20,ooo-ounce  demand  which  is  actual! v  reali/ed  because  a 
price  of  550  is  reached,  and  as  a  part  of  the  very  same  general 
situation,  we  have  various  potential  demands  which  would  just 
as  surely  be  realized  if  price  were  at  the  right  figure,  and  that 
without  any  other  change  in  tflie  forces  and  conditions  which  in- 
fluence demand.  In  Figure  2,  these  potential  demands  at  54c,  53C, 


40 


201 


24, 


55 


and  52c  are  represented  by  rectangles  which  are  lightly   shaded 

166. 


CHAPTER  VIII.     SUPPLY  AND   DEMAND 

in    contrast    with    the    deeply    shaded    rectangle    of    the    demand 
which  is  actually  realized  at  55c. 

We  have  seen  that,  given  the  present  attitude  of  buyers, 
the  amount  demanded  by  them  would  be  larger  if  price  were 
lower  than  the  going  price  of  55c.  It  is  hardly  necessary  to  say 
that  the  complement  of  this  statement  is  equally  true.  Given  the 
present  mental  attitude  of  buyers,  the  amount  demanded  by  them 
would  be  smaller  if  price  were  higher  than  55c,  instead  of  lower. 
Thus,  some  of  the  people  whose  offer  to  buy  at  55c  aggregated 
120,000  ounces,  would,  if  price  rose  to  56c,  withdraw  a  part  or 
all  of  their  former  dennand ;  they,  or  others,  would  withdraw 
still  more  of  that  demand,  if  price  rose  to  57c;  still  more,  if  it 
rose  to  58c ;  and  so  on.  That  is,  as  a  part  of  the  same  general 
situation  from  which  we  set  out,  we  have  a  series  of  potential 
demands  at  prices  above,  as  well  as  at  prices  below,  the  assumed 
one  of  55c.  Supposing  these  new  demands  to  be  110,000  ounces 
at  560.  80,000  ounces  at  5/c,  40,000  at  s8c,  and  so  on,  and  combin- 
ing them  with  the  demands  brought  out  in  our  last  diagram,  we 
should  have  the  result  represented  in  Figure  3.  That  is,  starting 

ff  .  .  ."P.   .  .«P.  .   .'3°        .'»>.   .  .W.   .   .y. 


Fig.3. 


with  the  actual  price  of  a  particular  day  and  the  demand  which 
led  to  actual  purchases,  we  can  be  sure  that  on  this  very  same 
day  the  mental  attitude  of  buyers  was  sudh  that  they  would  have 
taken  a  larger  amount,  if  price  had  been  one  step  lower;  a  still 
larger,  if  price  had  been  two  steps  lower;  and  so  on;  while,  on 
the  other  hand,  at  the  same  time  the  attitude  of  buyers  was  such 
that,  if  price  had  been  one  step  higher,  they  would  have  taken 
a  smaller  amount;  if  price  ihad  been  two  steps  higher,  they  would 
have  taken  a  still  smaller  amount ;  and  so  on. 

In  the  above  analysis  we  have  conceived  the  initial  demand 
and  price  as  a  demand  and  price  which  were  actually  realized 
on  some  particular  day.  Obviously,  we  are  at  liberty  to  conceive 

167 


PRINCIPLES  OF  ECONOMICS 


this  demand  in  the  same  way  as  the  others,  i.  e.,  as  a  potential 
demand, — the  demand  that  would  be  realized  if  actual  price 
were  55  'cents.  Further,  for  various  reasons  this  way  of  con- 
ceiving the  matter  will  best  suit  our  purposes,  especially  when  we 
are  considering  the  more  fundamental  problems  and  processes 
of  price-determination,  and  are  called  on  to  ascertain  the  very 
thing  hitherto  assumed,  namely  what  price  will  tend  to  be  estab- 
lished as  the  result  of  a  given  set  of  conditions,  including  the 
demand  schedule.  Amending  our  diagram  in  accord  with  tlhis 
altered  way  of  conceiving  the  demand  schedule  and  omitting  the 
inoperative  parts  of  our  rectangles,  we  shall  have  the  result  given 
in  Figure  4. 

From  the  preceding  discussion,  we  have  learned  that  demand  is 
always  relative  to  a  particular  price  stated  or  implied,  and  that  the 


9        ,4iQ. 


55 


amount  of  demand  is,  generally  speaking,  inversely  proportional 
to  price;  the  lower  the  price,  the  greater  the  demand;  the  higher 
the  price,  the  smaller  the  demand.  It  follows  that  the  facts  of 
demand  at  any  time  require  for  their  adequate  statement  a  series 
of  conditional  propositions.  Thus,  the  supposed  case  for  silver 
would  be  most  adequately  stated  as  follows : — 

The  demand  would  be  40,000  oz.  if,  and  only  if,  price  were  580  or  lower. 
The  demand  would  be  80,000  oz.  if,  and  only  if,  price  were  570  or  lower. 
The  demand  would  be  110,000  oz.  if,  and  only  if,  price  were  560  or  lower. 
The  demand  would  be  120,000  oz.  if,  and  only  if,  price  were  ssc  or  lower. 
The  demand  would  be  130,000  oz.  if,  and  only  if,  price  were  540  or  lower. 
The  demand  would  be  160,000  oz.  if,  and  only  if,  price  were  530  or  lower. 
The  demand  would  be  200,000  oz  if,  and  only  if,  price  were  520  or  lower. 

Such  a  series  of  propositions,  we  call  a  demand  schedule.     In 
order  to  abridge  the  statement  of  it,  we  will  put-  it  in  the  form 

168. 


CHAPTER  VIII.     SUPPLY   AND   DEMAND 


TABLE  i. 

Price 

Demand 

cents 

OOO     02. 

58 

40 

57 

80 

56 

1  10 

55 

I2O 

54 

130 

53 

160 

52. 

2OO 

of  two  columns  of  figures  with  the  prop- 
er headings,  Price  and  Demand ;  but  the 
student  must  always  remember  that  it  is, 
in  effect,  a  series  of  conditional  state- 
ments, such  as  those  already  given;  i.  e., 
in  each  case  it  is  affirmed  that  the  de- 
mand would  be  so  and  so  if,  and  only 
if,  the  price  were  so  and  so.  Presented 
in  this  way,  the  above  demand  schedule 
will  appear  as  in  Table  I.  The  schedule 
just  given  probably  comes  nearer  to 
representing  the  facts  of  experience 
than  a  more  symmetrical  one  would. 
But  as  our  purpose  in  using  these  TABLE  2. 

schedules     is     primarily    pedagogical,  I       Price  Demand 

shall     change     this     one     to     a     form       cents  ooo   oz 

which  can  be  used  more  effectively  in          60  70 

clearing  up  the  theory  of  prices.       In          59  80 

this  new  schedule,  we  will  make  the  vari-          5§  9° 

ations     of     demand     consequent     upon          57  IO° 

changes    in    price    uniform,    viz.,    10,000          56  IIQ 

ounces  in  each  case.     Thus  altered,  and          55  I2° 

carried  both  higher  and  lower,  our  sched-          54 
ule  will  appear  as  in  Table  2.     In  dia-          53  I4° 

grammatic  form  it  is  presented  in  Fig-          52 
ure  5.  51  l6° 

As    the    points    brought    out    in    the 


8.0 


120 


f60 


60- 


55 


PRINCIPLES  OF  ECONOMICS 

preceding  discussion  are  of  much  importance  in  later  connections, 
we  will  give  them  the  emphasis  derived  from  definite  formation  in 
a  principle  which  we  will  call  the  law  of  the  inverse  elasticity  of 
demand. 

Principle.     The  Law  of  the  Inverse  Elasticity  of  Demand. 

Demand  is  always  relative  to  a  particular  price  expressed  or 
implied;  and,  broadly  speaking,  varies  inversely  as  said  price, 
though  not  proportionally. 

Note:  A  point  of  much  importance  which  should  be  noted 
here  is  the  ambiguity  in  our  use  of  the  expression  "demand  has 
changed."  In  one  connection,  we  employ  this  language  to  mean 
that  demand  at  a  given  price  is  different  from  what  it  was  at  the 
same  price.  In  another  connection,  it  means  that  demand  without 
respect  to  price  has  changed.  This  last  meaning  is  necessary  just 
because  demand  is  conditioned  upon  price,  and  so  can  be  changed 
because  price  has  changed.  The  fact  really  is  that  the  former 
use  of  the  phrase  is  not  quite  accurate.  When  we  say  that  de- 
mand ,at  some  one  price  has  changed  from  what  it  was  at  the 
same  price,  we  really  mean  that  the  demand  schedule  has 
changed;  so  that  we  might  avoid  the  confusion  by  using  this 
phrase  "the  demand  schedule  has  changed;'  when  we  are  dealing 
with  a  case  where  demand  at  the  same  price  is  different, — reserv- 
ing the  expression  "demand  has  changed"  for  the  cases  where 
the  change  is  due  to  a  change  in  price  itself.  As  usage  in 
language  matters  is  extremely  persistent,  we  are  not  at  all  likely 
to  make  this  change.  We  should  therefore  take  much  pains  to 
distinguish  carefully  the  two  meanings;  for  confusion  at  this 
point  has  in  the  past  proved  to  be  the  source  of  a  very  consider- 
able amount  of  fallacious  reasoning. 

3.  The  Interpretation  of  Demand  Schedules. 
As  we  shall  constantly  be  called  upon,  during  our  study  of 
the  theory  of  price,  to  make  a  discriminating  use  of  demand 
schedules,  it  is  very  important  that,  at  the  outset,  we  gain 
familiarity  with  the  true  nature  and  significance  of  these  sched- 
ules and  their  various  parts.  First,  it  is  to  be  noted  that  demand 
at  any  particular  price  is  a  composite,  made  up  of  many  sections 
or  increments,  each  one  of  which  would  appear  at  some  higher 
price.  To  clear  this  up,  let  us  start  with  the  lowest  line  in  our 
demand  schedule  on  page  169,  i.e.,  the  demand  at  50  cents.  Mani- 
festly, this  170,000  ounces  consists  of  the  10,000  which  only  came 
in  when  price  fell  to  5oc,  added  to  the  160,000  already  wanted 
at  5ic.  But  this  160,000  ounces,  in  turn,  consists  of  the  10,000 
which  came  in  at  STC,  added  to  the  150,000  already  wanted  at 
52c.  This  150,000  ounces,  again,  is  the  lo.ooo  coming  in  at  52C 
added  to  the  140,000  wanted  at  530,  and  so  it  would  be  all  the 

170. 


CHAPTER  VIII.     SUPPLY  AND   DEMAND 


way  up  the  line.  Accordingly,  the  170,000  ounces  wanted  at  5oc 
is  the  sum  of  all  the  increments  of  demand  which  would  suc- 
cessively appear,  if  price  were  to  pass  through  all  stages  from  the 
highest  to  tihe  lowest.  This  is  brought  out  in  Figure  6,  in  which 

n  *o  60  120 


20  160 

L-J — . — i— ! — » 


60 


55- 


5C 


a 

b 

c 

d 

e 

i 

q 

b 

c 

d 

e 

f 

9 

h 

b 

c 

d 

e 

f 

q 

h 

i 

b 

c 

d 

e 

t 

q 

h 

b 

c 

d 

e 

f 

9 

h 

k 

b 

c 

d 

e 

f 

9 

h 

k 

1 

* 

b 

c 

d 

e 

f 

q 

h 

K 

1 

m 

b 

c 

d 

e 

f 

•9 

h 

k 

1 

m 

n 

b 

c 

d 

e 

f 

q 

h 

k 

I 

m 

n 

0 

b 

c 

d 

e 

f 

g 

h 

k 

j 

m 

n 

o    p 

b 

c 

d 

e 

f 

q 

h 

k 

I 

m 

n 

L£_  P 

Rg.6. 


the  small  letters  represent  the  successive  additions  to  demand 
which  are  supposed  to  take  place  at  each  price.  Thus,  q  conies 
in  at  soc  itself;  p  came  down  from  510;  o,  from  52c;  n,  from 
53c ;  m.  from  54c ;  I,  from  55c ;  and  so  on. 

Another  point  which  is  closely  tied  up  with  the  preceding  and 
which  is  evident  enough,  tlhough  at  times  forgotten,  is  that  we 
must  always  conceive  the  demand  figures  at  different  prices  as 
alternatives  which  mutually  exclude  each  other.  Thus,  if  the 
price  is  54c,  then  the  demand  is  just  the  amount  wanted  at  that 
price,  150,000  ounces.  It  is  not  this  demand  plus  that  at  55C> 
plus  that  at  56c,  plus  that  at  57c,  and  so  on.  These  higher  price 
demands  have  already  been  included.  The  demand  at  54  cents 
as  given  covers  everything  which  has  preceded  that  figure. 

Another  important  matter  to  be  brought  out  in  our  analysis 
of  demand  schedules,  concerns  the  different  divisions  into  which 
these  sections  or  increments  of  demand  group  themselves  just 
as  soon  as  any  particular  price  is  established.  Tlhe  first  break 
manifestly  is  between  the  excluded  increments  and  the  included 
ones.  Thus,  if  price  proves  to  be  55  cents,  all  the  increments  of 
demand  which  depend  upon  a  price  lower  than  this  will,  of  course, 
be  shut  out ;  while  all  increments  which  depend  upon  this  or  a 
higher  one  will  be  included,  for  tihe  man  who  was  ready  to  buy 
at  56c  or  57c  or  58c  will  surely  be  in  the  same  frame  of 
mind  if  price  falls  to  550.  In  Figure  7,  the  included  increments 

171 


PRINCIPLES  OF  ECONOMICS 


of  demand  are  represented  by  .the  shaded  squares,  and  the  price 
at  which  each  comes  in  is  indicated  by  its  position.*  The  excluded 
increments  of  demand  are  represented  by  the  uncolored  squares. 

0  40  8.0  140  160  200  ^40 

1  .         .         I         I         .        . , | , 1 1       T        I 1 1 1 1 1 1 1 1 1 " 1 L_ 


60- 


55- 


Xncluded 


c\uded 


Another  and  more  important  grouping  of  the  different  in- 
crements divides  the  included  ones  into  marginal  and  intra-mar- 
einal,  and  distinguishes  the  excluded  ones  as  extra-marginal. 
/The  marginal  increment  of  demand  is  that  addition  to  demand 
I  which  was  the  last  to  appear  when  an  actual  price  was  being 
/  established.  In  Figure  7,  it  is  represented  by  the  lowest  of  the 
shaded  squares,  labeled  "Marg";  for  this  10,000  ounces, 
which  would  not  have  been  wanted  lhad  actual  price  been  6oc 
or  5pc  or  sSc,  i.e.,  which  was  wanted  only  because  actual  price 
fell  as  low  as  55c,  must,  plainly,  be  the  last  addition  to  demand. 
In  a  sense,  this  increment  of  demand  is  more  significant  in 
price-determination  than  any  other;  since  it  is  the  desire  of 
sellers  to  bring  out  this  particular  10,000  ounces  of  demand  which 
leads  them  to  bid  price  down  to  55  cents.  On  account  of  the 
peculiar  location  of  this  section  of  demand,  i.e.,  because  it  is 
the  last  increment  of  demand  which  can  be  satisfied  at  the  going 
price  of  55  cents,  it  is  called  the  marginal  increment  of  demand. 
This  makes  it  natural  to  distinguish  all  other  included  sections 
or  increments  of  demand, — i.e.,  all  sections  which  are  realized 
because  conditioned  upon  prices  at  least  as  high  as  55  cents, — as 

*  Obviously,  there  are  several  more  included  increments  of  demand 
which  do  not  appear  in  the  diagram,  because  they  came  in  at  prices  higher 
than  are  provided  for  in  this  diagram. 

172 


CHAPTER  VIII.     SUPPLY  AND   DEMAND 


being  within  the  margin,  and  hence  to  designate  them  intra- 
marginal  increments  or  sections  of  demand.  On  the  other  hand,^ 
the  excluded  sections  of  demand,  i.e.,  the  sections  or  increments 
which  would  appear  only  if  price  fell  to  figures  lower  than  55 
cents,  being  without  the  margin,  are  naturally  called  extra- 
marginal  increments  or  sections  of  demand.  As  will  later  appear, 
it  is  chiefly  the  first  among  the  extra-marginal  increments  oi  de- 
mand whic'h  plays  a  vital  role  in  the  immediate  determining  of 
prices. 

A  point  about  the  marginal  increment  of  demand  which  is  of 
much  importance,  though  at  the  same  time  quite  obvious,  is  that 
said  marginal  increment  is  the  one  which  comes  in  with  that 
price,  among  all  the  prices  at  which  any  increment  of  demand 
comes  in.  which  is  the  lowest  -of  the  series.  Thus,  in  Figure  7, 
with  a  price  of  55  cents,  the  prices  at  which  the  included  incre- 
ments of  demand  come  in  are  55  cents,  56  cents,  57  cents,  58 
cents,  and  so  on ;  and  it  is  the  lowest  of  these,  55  cents,  at  wlhich 
the  last  or  marginal  increment  of  demand  conies  in. 

This  lowest  price  of  the  series  of  prices  at  which  increments 
of  demand  come  in,  viewed  as  the  price  on  which  is  conditioned 
the  forth-coming  of  the  marginal  increment  of  demand,  is  a  con- 
cept of  prime  importance  in  our  present  study,  and  will  be 
designated  the  marginal  demand  price.  Clear  and  definite  notions 
concerning  it  can  best  be  attained  by  starting  with  the  (hypothesis 

O  40  80  120  IfO  t 


InTra 
Marojlnaf 


Maroji  nal 


Extra- 
Marginal 


Fig*. 


that  demand  remains  constant  through  several  changes  in  price.* 

*  As  we  shall  learn  in  the  next  chapter,  long-time  demand  schedules, 
i.  e.,  schedules  which  sum  up  the  demand  facts  for  a  whole  period,  often 
show  this  peculiarity. 

173 


PRINCIPLES  OF  ECONOMICS 

Such    a    demand    schedule    is    represented    in    the    accompanying 

table   and  Figure  8.       Since  in   this   case   there   is   no   addition 

to  demand  after  59  cents  is  passed  until 

Demand  Price      53  cents  is  reached,  if  actual  price  were 

ooo    02  cents      55    cents,    the    marginal    demand    price 

50  62        would  be  59  cents, — that  being  the  price 

60  61        at    whidh    the    last    addition    to    demand 

70  60        was  made.     This  price,  59  cents,  would 

80  59        obviously    continue   to    be    the   marginal 

80  58        demand  price,  if  actual  price  rose  to  56 

80  57        cents  or  57  cents  or  58  cents  or  59  cents. 

80  56        If,    however,    actual    price    became    60 

80  55        cents,  the  marginal  demand  price  would 

80  54        change    to    60    cents;    since    the    10,000 

90  53        ounces    which    formerly   came    in   at    59 

loo  52        cents  would  no  longer  be  wanted,  and 

no  51        so    the    10,000   ounces    coming   in    at  60 

cents    would    be    the    last    increment    of 

demand.  As  indicated  at  the  outset,  this  marginal  demand  price 
is  the  lowest  of  all  the  prices  on  ivhich  depends  the  coining  in  of 
any  portion  of  the  effective  or  included  demand.  In  the  example 
just  used,  with  actual  price  at  55  cents,  no  portion  of  the  demand 
which  is  conditioned  on  a  price  of  54  cents  or  less  would  be 
effective;  for  it  is  obvious  that  the  demand  of  a  buyer  who  wants 
silver  only  on  condition  that  its  price  is  as  low  as  54  cents  will 
not  be  satisfied  at  all  when  the  price  is  55  cents.  On  the  other 
hand,  it  is  equally  evident  that  all  otlwr  portions  of  demand 
will  be  effective  when  actual  price  is  55  cents;  since  thexparti- 
cular  prices  to  which  actual  price  must-  fall  in  order  to  bring 
out  these  other  portions  of  demand  are  all  higher  than  55  cents, 
being  59  cents,  60  cents.  61  cents,  and  so  on.  Finally,  among 
these  prices  wihich  are  necessary  to  bring  out  the  effective  por- 
tions of  demand,  the  lowest,  59  cents,  is  the  one  which  is  neces- 
sary to  bring  out  the  last  or  marginal  increment  of  demand,  and 
is,  therefore,  the  marginal  demand  price. 

Under  the  demand  schedule  represented  in  Figure  8,  the  mar- 
ginal demand  price  was  59  cents,  even  though  actual  price  was  as 
low  as  55  cents.  The  typical  market  schedule,  however,  is  more 
like  tUiat  represented  in  Figure  7.  In  such  a  case,  the  marginal 
demand  price  would  necessarily  coincide  with  the  actual  price. 

174 


CHAPTER  VIII.     SUPPLY  AND   DEMAND 

The  reason  is  plain.  With  every  fall  in  price,  some  addition  to 
demand  takes  place;  hence,  whatever  price  in  the  series  became 
the  actual  price,  some  portion  of  the  demand  would  be  forth- 
coming only  because  that  particular  price  was  established;  and 
so  that  price  would  be  the  marginal  demand  price  as  well  as  the 
actual  price.  But  the  fact  that,  in  the  cases  chosen  as  typical, 
actual  price  and  marginal  demand  price  necessarily  coincide,  does 
not  make  the  latter  concept  superfluous  or  useless.  As  already 
hinted,  we  shall  later  meet  long-time  schedules  wherein  these 
quantities  do  not  coincide;  and.  even  when  they  do  coincide,  they 
are  after  all  essentially  different  things, — one,  the  marginal  de- 
mand price,  being  in  part  at  least  the  determinant  of  the  other, 
actual  price.  / 

Besides  the  marginal  demand  price,  we  s'hall  have  occasion  to 
distinguish  the  first  extra-marginal  demand  price:  i.e.,  the  price 
which  would  be  necessary  to  make  actual  the  first  extra-marginal 
increment  of  demand.  Under  the  demand  schedule  represented 
in  Figure  8,  the  first  extra-marginal  demand  price  would  be  54 
cents,  as  long  as  actual  price  was  anything  from  55  cents  up  to 
59  cents.  If  actual  price  rose  to  60  cents,  the  first  extra-marginal 
demand  price  would  be  59  cents.  If  actual  price  fell  to  54  cents, 
the  first  extra-marginal  demand  price  would  be  53  cents.  As 
a  correlate  of  the  first  extra-marginal  demand  price,  we  have  the 
first  intra -marginal  demand  price,  meaning  the  price  which  was 
necessary  to  bring  out  the  next  to  the  last  increment  of  demand. 
In  Figure  8,  this  first  intra-marginal  demand  price  would  be  60 
cents  for  any  price  from  55  cents  to  59  cents. 

A   few  pages  back,   we  explained  the  meaning  of  the  phrase 
"marginal   section  or  increment  of  demand."     A  closely  related  I 
concept  of  some  importance  is  the  total  demand  at  the  marginal  I 
demand  price, — we  will  designate  it  simply  the  marginal  demand.  1 
This  of  course  covers,  not  just  that  increment  of  demand  which 
becomes  effective  at  the  marginal  demand  price,  but  all  the  de- 
mand that  is  effective  at  that  price,  whether  it  is  new  or  is  brought 
over   from   higher  prices.     Just  as  marginal  demand  means   the 
total   demand  at  the  marginal   demand  price,   so  the  first  intra- 
marginal  demand  and  the  first  extra-marginal  demand  mean  the 
total  demands  at  the  first  intra-marginal   demand  price  and  the 
first  extra-marginal  demand  price  respectively. 

It  is  hardly  necessary  to  say  that  we  often  have  occasion  to 

175 


PRINCIPLES  OF  ECONOMICS 

apply  the  terms  marginal,  extra-marginal,  and  intra-marginal  to 
buyers.  The  meaning  is  fairly  obvious.  Marginal  buyers  are 
those  who  make  some  or  all  of  their  purchases  only  when,  and 
because,  price  has  fallen  to  the  point  ivhere  it  is.  In  other  words, 
the  marginal  buyers  are  the  ones  who  are  responsible  for  the  mar- 
ginal increment  of  demand.  So,  the  intra-marginal  buyers  are 
the  ones  who  are  responsible  for  the  intra-marginal  increments  of 
demand.  Their  purchases  would  be  assured,  even  if  price  were 
higher  than  it  proves  to  be.  The  extra-marginal  buyers  are  the 
ones  who  are  responsible  for  the  extra-marginal  increments  of 
demand.  They  make  no  purchases  and  are  frequently  called  the 
excluded  buyers. 

ILLUSTRATIVE  PROBLEMS. 

1.  Suppose  that  the  demand  schedule  for  silver  at  a  certain 
time  is  represented  by  the  accompanying  table,  and  answer  the 
questions  which  follow. 

(a)     Interpret    the    first    three    lines; 
Demand  Price      the  last  five  lines. 

ooo  os.  cents  (b)     Wlliat    would    be    the    marginal 

increment    of    demand    if    actual    price 

66  68        were  67  cents  ?    65  cents  ?    63  cents  ?     59 

70  67        cents?     57  cents?     55  cents? 

70  66  (c)     What  would   be  the  first  extra- 

70  65         marginal  increment  of  demand  if  actual 

84  64        price    were    66    cents?      65    cents?      61 

92  63         cents?     59  cents?     54  cents? 

loo  62  (d)     What   would  be   the  first  intra- 

100  61        marginal'  increment  of  demand  if  actual 

loo  60        price    were    65    cents?      64    cents?      62 

100  59        cents?     59  cents?     55  cents? 

107  58  (e)     What    would    be    the    marginal 

120  57        demand    price    if    actual    price    were    67 

120  56        cents?     66  cents?     63  cents?     60  cents? 

120  55        56  cents?     52  cents? 

133  54  (f)     What  would  be  the  first  extra- 

145  53        marginal    demand   price    if    actual    price 

145  -    52        were   65    cents?      66   cents?     67    cents? 

156  51        63  cents? 

(g)     Who     would    be    the     marginal 

buyers  if  actual  price  were  66  cents?  53  cents?  55  cents?  60 
cents?  54  cents? 

(h)  What  would  be  the  first  intra-marginal  demand  price 
if  actual  price  were  66  cents?  62  cents?  59  cents?  54  cents? 
55  cents? 

(0  Who  would  be  the  first  extra-marginal  buyer  if  actual 
price  were  66  cents?  65  cents?  61  cents?  58  cents?  56  cents? 
52  cents? 

(j)     Who  would  be  the   first   intra-marginal  buyer  if  actual 

176 


CHAPTER  VIII.     SUPPLY  AND   DEMAND 

price  were  65  cents?    67  cents?    62  cents?     59  cents?     56  cents? 
5,3  cents? 

2.  Suppose  that  on  the  second  Saturday  of  October  a  sec- 
tion of,  the  demand  schedule  for  wood  in  Ann  Arbor  is  as  fol- 
lows:  i  cord  wanted  at  $6;  2  at  $5.75;  4  at  $5.50;  3  more  at  $5.25; 
3   more  at  $5 ;  7  more  at  $4.75;   8  more  at  $4.50;  and  so   on. 
Put  it  into  tabular  form. 

3.  Suppose  that  the  conditions  of  demand  for  Milton's  auto- 
graphs are  such  that  1  would  be  wanted  if  the  price  were  $200; 
2  if  price  were  $175;  4  if  $150;  5  if  $140;  8  if  $125;  9  if  $110; 
12  if  $100;  13  if  $90;  15  if  $75;  and  20  if  $50.     Put  this  demand 
schedule   into  tabular  form. 

(If  the  problem  had  said:  1  wanted  at  $200;  2  at  $175;  and 
so  on,  it  would  have  meant  the  same  thing.) 

Section   B.     Supply, 
i.     The  Nature  of  Supply. 

We  have  considered  one  of  the  two  essential  elements  in  price- 
determination,  demand ;  we  must  now  take  up  the  second,  sup- 
ply. In  general,  we  shall  understand  the  supply  of  any  commodity 
to  mean  the  quantity  of  that  commodity  which  sellers  stand 
ready  to  dispose  of  at  some  specific  price.  Here  we  need  to 
emphasize,  first,  the  statement  that  supply  is  the  amount  which 
sellers  stand  ready  to  dispose  of.  That  is,  the  supply  of  anything 
should  not  be  confused  either  (a)  with  the  total  amount  in  the 
hands  of  producers  or  dealers,  or  (b),  on  the  other  hand,  with 
the  amount  actually  sold.  Supply  should  not  be  confused  with 
the  total  amount  in  the  hands  of  producers  or  dealers.  This 
total  we  call  stock;  and  only  a  part  of  it  constitutes  supply,— 
i.e.,  so  much  of  it  as  people  stand  ready  to  sell  at  some  price  or 
other.  But,  though  supply  is  not  the  same  as  stock,  it  is  hardly 
necessary  to  say  that  stock  is  the  immediate  source  of  supply, 
and,  therefore,  plays  a  large  part  in  determining  supply.  On  the 
one  hand,  it  always  sets  an  upward  limit  to  supply.  On  the 
other  hand,  it  exists  only  to  become  supply,  and,  therefore,  must 
ultimately  make  supply  as  large  as  itself.  The  supply  of  wheat 
in  the  market  today  may  be  only  id,ooo,ooo  bushels,  though  the 
stock  is  1,000,000,000  bushels;  but,  in  the  course  of  the  season, 
substantially  all  of  the  1,000,000,000  bushels  is  bound  to  be  offered 
for  sale,  and,  therefore,  taking  the  season  as  a  whole,  the  supply 
is  certain  to  become  substantially  coincident  with  the  stock.* 

*  It  follows  from  the  last  statement  that  the  above  distinction  between 
stock  and  supply  is  more  particularly  applicable  in  the  discussions  of  the 
present  chapter.  When  we  come  to  consider  normal  price,  the  price  which 

177 


PRINCIPLES  OF  ECONOMICS 

Again,  supply  must  not  be  confused  with  the  amount  actually 
sold.  The  reason  is  analogous  to  that  which  was  given  to  show 
that  we  should  not  confuse  demand  with  the  amount  bought. 
As  a  matter  of  fact,  "the  amount  which  people  stand  ready  to 
dispose  of"  may  be,  but  need  not  be,  equal  to  "the  amount  which 
is  actually  sold."  But,  even  if  the  two  were  always  quantitatively 
equal,  the  meaning,  the  connotation  of  the  two  phrases  would 
be  different.  "The  amount  which  sellers  stand  ready  to  dispose 
of"  pi-ays  a  very  great  part  in  determining  price;  but  "the  amount 
actually  sold"  is  itself  determined  after  price  is  determined. 

We  have  elaborated  the  point  that,  by  our  definition,  supply 
is  the  amount  which  sellers  stand  ready  to  dispose  of.  We  must, 
in  the  second  place,  emphasize  the  phrase  ''at  some  specific  price." 
The  insertion  of  this  plhrase  means  that  no  statement  affirming 
the  existence  of  a  given  volume  of  supply  can  be  recognized  as 
adequate  unless  it  represents  supply  as  conditioned  on  some  par- 
ticular price.  Thus,  it  is  proper  to  say,  "The  supply  of  silver  is 
120,000  ounces  at  55  cents  an  ounce" ;  but  it  is  not  proper  to  say, 
"The  supply  of  silver  is  120,000  ounces," — leaving  out  any  mention 
of  price. *  For,  of  course,  the  latter  statement,  literally  inter 
preted,  means  that  sellers  stand  ready  to  dispose  of  120,000 
ounces  whether  the  price  be  low  or  high;  and,  obviously,  such  a 
statement  would  in  most  cases  be  very  absurd  indeed. 

Note :  In  the  case  of  producible  goods,  we  should  note  an- 
other concept,  closely  related  to  supply  but  still  distinguishable 
from  it.  I  mean  "output."  Output  is  the  amount  produced.  In 
substance,  it  will  usually  be  identical  with  stock ;  but  it  is  logically 
distinguishable  from  the  latter,  and,  in  various  connections,  this 
distinction  is  of  importance. 

2.     The  Relation  of  Supply  to  Price. 

We  have  already  seen  that  supply  like  demand  is  always  rela- 
tive to  a  specific  price.  We  must  now  explain  this  relation  more 
precisely.  Let  us  start  with  a  hypothesis  analogous  to  that  used 
in  the  case  of  demand;  i.e..  let  us  suppose  that  on  a  certain  day 
the  price  of  silver  proves  to  be  55  cents  an  ounce,  and  that,  at 
this  price,  sellers  offer  to  dispose  of  120,000  ounces,— thus  making 
this  amount  the  realized,  effective  supply.  In  the  accompanying 

tends  to  prevail  over  some  considerable  period,  we  usually  have  to  con- 
sider supply  as  conterminous  with  stock. 

*  Unless    there    is    an    understanding    between    the    person    making    the 
statement  and  the  person  to  whom  it  is  made  that,  when  no  pru 
tioned,  the  current  market  price  is  implied. 

173 


CHAPTER  VIII.     SUPPLY  AND   DBMAND 

diagram,  this  120,000  ounces  is  represented  by  the  shaded  portion, 
SS',  of  the  broken  rectangle  SS'S",  —  tJhat  rectangle,  as  a  whole, 

9  4p  ep          130  130          iqo         *|0 

(s 


ELo.9 

being  intended  to  represent  the  indefinite  volume  of  supply  at 
some  price  or  other.  If  now,  we  start  with  this  hypothesis  of 
120,000  ounces  actually  offered  for  sale  at  55  cents,  we  may  be 
quite  certain  that  the  Very  same  persons  who  are  offering  to  sell 
these  120,000  ounces  or,  anyhow,  some  other  persons,  are  prepared 
to  sell,  are  in  the  mental  attitude  to  induce  them  to  sell,  say, 
10,000  ounces  more  at  a  price  of  56  cents  ;  40,000  more  at  a  price 
of  57  cents;  80.000  more  at  a  price  of  58  cents;  and  so  on.* 
That  is,  right  alongside  the  120,000  ounce  supply  which  is 
actually  realized  because  its  price,  55  cents,  is  established,  and 
as  a  part  of  the  very  same  general  situation,  we  have  various 
potential  supplies  whicn  would  just  as  surely  be  realized  if  price 


/////////////////////, 


were  right,  and  that  without  any  further  change  in  the  forces 
and  conditions  which  influence  supply.  In  Figure  10,  these  po- 
tential supplies  are  represented  by  the  slightly  shaded  portions 
of  the  proper  rectangles,  while  the  actual  supply  at  55  cents  is 
represented  by  the  heavily  shaded  portions  of  the  proper  rec- 
tangle. 

We  have  seen  that,  given  the  present  attitude  of  sellers,  the 
amount  offered  by  them  would  be  larger  if  price  were  higher 
than  the 'going  price  of  55  cents.  Quite  as  true,  plainly,  is  the 

*  This  proposition  is  so  familiar  in  experience  and  so  clearly  follows 
from  the  fact  that  the  seller's  advantage  is  in  higher  prices,  that  we  may 
assume  its  acceptance  without  argument. 

179 


PRINCIPLES  OF  ECONOMICS 


complementary  proposition  that,  given  the  present  attitude  of 
sellers,  the  amount  offered  for  sale  would  be  smaller  were  price 
loiver.  That  is,  to  complete  our  schedule  of  supply  we  shall  have 
to  add  a  series  of  potential  supplies  at  prices  below,  as  well,  as  a 
series  at  prices  above,  the  assumed  market  price  of  55  cents. 
If  we  suppose  these  new  supplies  to  be  110,000  at  54  cents,  80,000 


8,0 


"P 


1°. 


at  53  cents,  40,000  at  52  cents,  and  so  on,  and  combine  them  with 
the  supplies  already  assumed  for  other  prices,  we  slhall  have  the 
results  which  are  represented  in  Figure  n.  Summarizing  these 
results,  we  can  say  that,  if  we  start  with  the  actual  price 
of  a  particular  -day  and  the  supply  which  led  to  actual  sales 
that  day,  we.  can  be  sure  that,  at  this  very  same  time,  the 
mental  attitude  of  sellers  was  such  that  they  would  have  offered 
for  sale  a  larger  amount,  if  price  had  been  one  step  higher; 
a  still  larger  amount,  if  price  had  been  two  steps  higher;  and 
so  on;  while,  on  the  other  hand,  at  this  very  same  time,  the 
mental  attitude  of  sellers  was  such  that  they  would  ihave  offered 
for  sale  a  smaller  amount,  if  price  had  been  one  step  lower; 
a  still  smaller  amount,  if  it  had  been  two  steps  lower;  and  so  on. 

200  '240 

I.I 1 L L_ 


4.0 


1° 


55 


'////////////////////////////////////////////////A 


Y/////////////////, 

V, 


r 


Fig  .12. 

In  the   above  analysis,   we   have  conceived  the   initial   supply 

180 


CHAPTER  VIII.     SUPPLY  AMD   DEMAND 

and  price  as  a  supply  and  price  which  were  actually  realized  on 
a  particular  day.  Obviously,  we  are  at  liberty  to  make  the 
same  shift  that  we  did  in  the  case  of  demand,  i.e.,  to  conceive 
this  55  cent  supply  as  a  potential  one  like  the  others.  Amending 
our  diagram  accordingly,  and  omitting  the  inoperative  portions 
of  the  rectangles,  we  shall  have  the  results  given  in  Figure  12. 

From  the  preceding  discussion,  we  have  learned  that  supply 
is  always  relative  to  a  particular  price  stated  or  implied,  and  that 
the  amount  of  supply  is,  generally  speaking,  directly  proportional 
to  price.  The  lower  the  price,  the  smaller  the  supply;  tlhe 
higher  the  price,  the  larger  the  supply.  It  follows  that  the  facts 
of  supply  at  any  time  require  for  their  adequate  statement  a 
series  of  conditional  propositions.  Thus,  the  supposed  case  for 
silver  would  be  most  adequately  stated  as  follows  : 

The  supply  would  be  200,000  oz.  if,  and  only  if,  price  were  580  or  higher. 

The  supply  would  be  160,000  oz.  if,  and  only  if,  price  were  570  or  higher. 

The  supply  would  be  130,000  oz.  if,  and  only  if,  price  were  560  or  higher. 

The  supply  would  be  120,000  oz.  if,  and  only  if,  price  were  550  or  higher. 

The  supply  would  be  1 10,000  oz.  if,  and  only  if,  price  were  540  or  higher. 

The  supply  would  be  80,000  oz.  if,  and  only  if,  price  were  530  or  higher. 

The  supply  would  be  40,000  oz.  if,  and  only  if,  price  were  $2C  or  higher. 

Such   a   series   of   propositions,   we   call   a   supply   schedule.     In 

order  to  abridge  the  statement  of  it,  we  will  put  it  in  the  form 

of    two  columns   of    figures    with    the 

TABLE  i.  proper  headings,  Price  and  Supply;  but 

the  student  must  always  remember  that 

Price  Supply      such  a  table  is  in  effect  a  series  of  state- 

cents  ooo  oz,      ments  like  those  given  above;   i.   e.,   in 

each  case  it  is  affirmed  that  the  supply 

58  200          would  be  so  and  so  if,  and  only  if,  price 

57  160          were  so  and  so.    Stated  in  this  new  way, 

56  130          the  above  schedule  would  appear  as  in 

55  120         Table  i. 

no  The  table  just  given  probably  has  more 

80          resemblance  to  one  whidh  would  repre- 

40          sent  the  facts  of  experience  than  a  more 

symmetrical  table  would  have.     But  for 

181 


PRINCIPLES  OF  ECONOMICS 


our  purpose,  which  is  primarily  ped- 
agogical, I  shall  change  this  schedule 
to  a  form  which  can  be  used  more 
effectively  in  clearing  up  the  theory  of 
prices.  In  this  new  schedule,  the  varia- 
tions of  supply  with  changes  in  price  are 
uniform,  being  10,000  ounces  in  each 
case.  Thus  altered  and  carried  both 
higher  and  lower,  our  schedule  will  ap- 
pear as  in  Table  2.  In  diagrammatic 
form  it  is  presented  in  Figure  13. 

As  the  points  brought  out  in  the  pre- 
ceding discussion  are  of  much  import- 
ance-ill later  connections,  we  will  give 
them  the  emphasis  derived  from  definite 
formulation  in  a  principle. 

p  4,0  8,0 


TABLE  2. 


60 


55- 


50- 


Price 
cents 

60 

59 

58 

'57 

56 

55 

54 

53 

52 

5i 

50 


Supply 
ooo  oz. 

170 

1 60 

150 

140 

130 

120 

IIO 

100 

00 

80 
70 


Principle:     The  Law  of  the  Direct  Elasticity  of  Supply. 

Supply  is  always  relative  to  a  particular  price  expressed  or 
implied  and,  broadly  speaking,  varies  directly,  though  not  pro- 
portionally, as  price. 

Note:  (i)  Remember  that  we  are  now  dealing  with  the 
immediate  supply  schedule,  the  supply  schedule  which  is  effective 
at  any  one  moment.  Later  we  shall  have  to  do  with  long-time 
or  normal  schedules,  i.e.,  schedules  for  a  whole  period  of  some 
length.  To  tlhese  latter  schedules,  the  principle  just  laid  down 
is  not  always  applicable.  In  one  set  of  cases,  the  supply  is 
equivalent  to  the  whole  stock  and,  therefore,  does  not  vary  at 
all.  In  another  set,  the  supply  is  a  potential  output  the  amount 

182 


CHAPTER  VIII.     SUPPLY  AND   DEMAND 


of  which  is  indefinitely  large,  provided  cost  of  production  is 
covered ;  and,  hence,  we  ihave  a  schedule  which  shows  no  supply 
at  prices  below  the  one  covering  cost  and  an  indefinitely  large 
supply  at  that  cost  price  and  others  above  it.  But  these  points 
will  be  more  fully  presented  later. 

(2)  The  expression  "supply  has  changed'5  gives  us  the  same 
ambiguity  that  we  found  in  the  case  of  demand.  That  is,  it  can 
mean  either  (i)  that  supply  at  a  particular  price  is  different  from 
what  it  was  at  the  same  price  or  (2)  that  supply,  without  respect 
to  price,  is  really  different  from  what  it  was.  This  second 
meaning  is  made  necessary  by  the  fact  brought  out  in  our 
previous  discussions  that  supply  is  relative  to  price, — will  change 
as  price  changes.  The  former  idea  would  be  more  precisely 
stated  by  saying  that  the  supply  schedule  has  changed.  'However, 
it  is  not  at  all  probable  that  we  should  be  able  to  bring  about  this 
change  in  usage.  It  is  quite  important,  therefore,  that  we  should 
watch  carefully  for  the  double  meaning  and  avoid  the  confusion 
likely  to  result  therefrom. 

3.  The  Interpretation  of  Supply  Schedules. 
First,  the  supply  at  any  particular  price,  like  the  demand  at 
the  same  price,  is  a  composite,  made  up  of  many  different  por- 
tions, each  one  of  which,  save  the  last,  would  appear  at  some 
lower  price.  To  make  this  clear,  let  us  begin  with  the  supply  at 
6oc,  170,000  ounces.  Manifestly,  this  170,000  ounces  consists  of 
the  10,000  which  comes  on  the  market  w'hen,  and  because,  price 
advances  from  5Qc  to  6oc,  added  to  the  160,000  already  offered 
when  the  price  was  only  SQC.  But  this  160,000,  in  turn,  consists 
of  the  10,000  which  comes  in  when,  and  because,  price  rises  from 
58c  to  sgc,  added  to  the  150,000  already  offered  at  s8c.  This 

9  4°          8i°          'f0         ifro. 


60- 


55- 


5G 


b 

c 

d 

e 

f 

9 

h 

1 

J 

h 

) 

m 

n 

ojp 

b 

c 

d 

c 

f 

9 

h 

i 

J 

h 

I 

m 

n 

o     p 

b 

c 

d 

e 

9 

h 

1 

i 

h 

I 

m 

n 

0 

9 

K 

i 

K 

1 

m 

n 

b 

c 

d 

C 

9 

h 

i 

j 

H 

I 

m 

b 

c 

d 

e 

g 

h 

i 

j 

K 

I 

b 

c 

ol 

e 

g 

h 

i 

j 

K 

b 

c 

d 

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f 

9 

h 

i 

j 

b 

c 

d 

e 

f 

g 

h 

i 

b 

c 

d 

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f 

g 

h 

Rg.14. 

183 


PRINCIPLES  OF  ECONOMICS 

150,000,  again,  is  the  10,000  coming  in  at  580  added  to  the  140,000 
already  offered  at  5/c.  In  short,  not  only  is  the  last  10,000  of  the 
170,000  offered  at  6oc  a  separate  unit,  the  previous  160,000  also 
consists  entirely  of  just  such  separate  units  which  have  been 
added  with  successive  steps  in  the  upward  movement  of  price. 
This  is  brought  out  in  Figure  14,  in  which  the  little  squares 
marked  with  small  letters  show  for  each  case  the  increment 
which  supply  receives  <as  price  rises  to  the  level  indicated.  The 
last  increment,  q.  of  the  6oc  rectangle  appeared  first  when  that 
price  itself  was  reached;/)  came  up  from  5gc;  o  from  s8c;  n 
from  57c ;  m  from  56c ;  and  so  on.  This  reasoning  is  particularly 
addressed  to  the  case  of  the  6oc  supply;  but  it  is  evident  that 
precisely  similar  reasoning  would  show  that  the  59c  supply,  the 
58c  supply,  and  so  on,  are  composites  made  up  of  increments 
brought  in  at  the  going  price  and  the  several  prices  below. 

The  point  just  brought  out  shows  that,  in  the  case  of  supply 
as  in  that  of  demand,  the  figure  given  at  a  particular  price  em- 
bodies all  the  supply  facts  for  that  price.  The  supply  at  55c  is 
not  the  amount  given  at  that  price  plus  the  amount  given  at  54C, 
plus  that  given  at  53c,  and  so  on.  These  latter  have  all  been 
taken  up  into  the  amount  given  at  55<c  itself ;  and,  hence,  the  55c 
figure  covers  the  whole  case  when  actual  price  is  55»c. 

With  supply,  as  with  demand,  it  is  important  to  distinguish 
the  different  divisions  into  which  the  different  sections  or  incre- 
ments of  supply  group  themselves  just  as  soon  as  any  particular 
price  is  established.  The  principal  grouping,  as  before,  is  into 
included  and  excluded  portions.  Thus,  if  price  is  55'c,  all  possible 
increments  of  supply  which  are  conditioned  on  a  price  of  55c 
or  anything  lower,  will  be  included  increments ;  while  all  possible 
increments  of  supply  which  are  conditioned  on  a  price  of  56c  or 
anything  higher,  will  be  excluded  increments.  Again,  among  the 
included  increments,  the  most  important  is  the  marginal  one,  i.  e., 
that  section  of  supply  which  is  the  last  to  come  in  when  a  par- 
ticular  price  is  being  established.  The  remainder  of  these  in- 
cluded increments  we  will  call  the  intra- marginal  increments. 
The  excluded  increments  will  also  be  called  the  extra -marginal 
ones.  The  location  of  these  various  sections  of  supply  is  plainly 
indicated  in  Figure  15. 

A  point  with  respect  to  the  marginal  increment  of  supply 
W'hich  is  of  much  importance,  though  perhaps  sufficiently  obvious, 

184 


ich  \ 
ny  1 


CHAPTER  VIII.     SUPPLY   AND   DEMAND 

is  that  the  marginal  increment  of  supply  is  the  increment  wh 
conies  in  with  that  price,  among  all  the  prices  under  which  any 
increments  of  supply  come  in,  which  is  the  highest.  Thus,  in  our 
example,  the  increment  of  supply  which  comes  in  at  55>c — the 
highest  of  the  prices  at  which  any  came  in — is  the  last  one  to 
come  in,  for  it  is  the  only  one  of  the  included  increments  which 
had  to  wait  until  a  price  of  55c  had  been  reached;  and,  being  the 
last,  it  is  by  definition  the  marginal  increment  of  supply.  This 
is  just  the  opposite  of  what  we  found  to  be  true  in  the  case  of 
demand.  For,  while  the  marginal  increment  of  supply  is  the  one 
which  comes  in  at  the  highest  of  all  those  prices  which  bring  in 
any  additions  to  supply,  the  marginal  increment  of  demand  is  the 
one  which  comes  in  at  the  lowest  of  all  those  prices  which  bring 

120  160 


9 


8.0 


200 


5C- 


uded 


Fig.15. 


in  any  additions  to  demand.  (Compare  Figures  7  and  15.)  The 
same  contrast  between  supply  and  demand  schedules  shows  in 
respect  to  the  intra-marginal  and  extra-marginal  increments,  i.  e., 
the  intra-marginal  increments  of  supply  are  increments  which 
come  in  at  a  price  below  the  marginal  one,  while  the  intra- 
marginal  increments  of  demand  are  increments  which  come  in  at 
prices  above  the  marginal  one.  On  the  other  'hand,  the  extra- 
marginal  increments  of  supply  are  increments  which  come  in  at 
prices  above  the  marginal  one,  while  t>he  extra-marginal  incre- 
ments of  demand  are  increments  which  come  in  at  prices  below 
the  marginal  one. 

Vitally  related  to  these  concepts  of  marginal,  intra-marginal, 


185 


PRINCIPLES  OF  ECONOMICS 

and  extra-marginal  increments  of  supply,  are  three  others  equally 
important,  namely,  the  marginal  supply  price,  the  intra- marginal 
supply  prices,  and  the  extra-marginal  supply  prices.  These  sev- 
eral phrases  designate  in  each  case  that  price  the  realization  of 
which  is  necessary  to  bring  out  the  cor- 

Price  Supply      responding    increment    of    supply.  '  The 

cents  ooo  oz.      concept  of  marginal  supply  price  is  best 

brought  out  by   supposing   for  the   mo- 

59  no          ment     that     supply     does     not     change 

58  zoo          with    every    dhange     in    price    but    re- 

57  90          mains     constant     under     several     prices. 

56  80          Such    a    supply    schedule    is    represented 

55  80          in  Figure  16  and  the  accompanying  table. 

54  80          After  the  5 re  price  has  'been  passed,  sup- 

53  80          ply   receives   no   increment  until   57c   is 

52  80          reached.      In    consequence,    5ic    is    the 

51  80          marginal  supply  price  so  long  as  actual 

50  70          price  is  anything  from  5ic  to  56c.  Under 

49  60          an   actual   price   equal   to   any  of   these, 

48  50          the  intra-marginal  supply  prices  are  5oc, 

49c,  and  so  on ;  while  the  extra-marginal 
supply  prices   are   57c,   58c,   and   so   on. 

In  these  cases  of  marginal,  intra-marginal,  and  extra-marginal 
prices,  we  have  the  same  antithesis  between  supply  and  demand 
schedules  as  has  appeared  in  other  connections.  Thus,  the  mar- 
ginal supply  price  is  the  highest  of  all  the  prices  on  which  depends 
the  coming  in  of  the  included  increments  of  supply;  while,  as  we 
saw,  the  marginal  demand  price  is  the  loivest  of  the  prices  on 
which  depends  the  coming  in  of  the  included  increments  o>f  de- 
mand. A  like  antithesis  shows  between  the  intra-marginal  supply 
prices  and  the  intra-marginal  demand  prices,  also  between  the 
extra-marginal  supply  prices  and  the  extra-marginal  demand 
prices. 

The  supply  schedule  embodied  in  Figure  16  was  purposely  so 
constructed  as  to  make  it  possible  for  the  marginal  supply  price 
to  differ  from  the  actual  price.  But,  as  in  the  case  of  demand, 
the  typical  supply  schedule  for  any  moment  is  more  commonly 
like  the  one  given  in  Figure  15 ;  and,  under  that  schedule,  the 
marginal  supply  price  and  the  actual  price  would  necessarily 
coincide.  Nevertheless,  the  concept  of  marginal  supply  price  is 
not  superfluous.  As  will  presently  appear,  this  coincidence  of 

186 


CHAPTER  VIII.     SUPPLY  AND   DEMAND 


the  marginal  supply  price  and  the  actual  price  is,  in  part  at  least, 
due  to  the  fact  that  the  marginal  supply  price  determines  the 
actual  price,  i.  e.,  brings  said  actual  price  into  coincidence  with 
itself;  and  this  becomes  a  fact  of  much  importance  in  the  deeper 
determination  of  prices,  which  we  study  in  the  next  chapter. 
In  the  preceding  discussion,  we  explained  the  meaning  of  the 
phrase  marginal  section  or  increment  of  supply.  A  closely 
related  concept  of  some  importance  is  the  total  supply  at  the 
marginal  supply  price, — we  will  designate  it  simply  marginal 
supply.  This,  of  course,  includes  not  just  the  increment  of 
supply  which  becomes  effective  at  the  marginal  supply  price,  but 
rather  all  the  supply  which  is  effective  at  that  price,  whether  new 
or  brought  up  from  lower  prices.  Just  as  marginal  supply  means 


? .  .  . 


6.0 


160 


55 


50 


Extra-Marginal 


Marginal 


I  ntra- Marginal 


Fig.16. 

the  total  supply  at  the  marginal  supply  price,  so  the  first  intra- 
marginal  supply  and  the  first  extra-marginal  supply  mean  the 
total  supplies  at  the  first  intra-marginal  supply  price  and  the  first 
extra-marginal  supply  price  respectively. 

It  is  hardly  necessary  to  add  that  we  often  have  occasion  to 
apply  the  terms  marginal,  intra-marginal,  and  extra-marginal  to 
sellers.  The  meaning  is  obvious.  Marginal  sellers  are  those 
who  offer  to  sell  some  or  all  of  their  offerings  only  when,  and 
because,  price  has  risen  to  the  point  where  it  is.  In  other  words, 
marginal  sellers  are  the  ones  who  are  responsible  for  the  marginal 
increments  of  supply.  Their  offerings  would  be  made,  even  if 
price  were  lowered.  Extra-marginal  sellers  are  those  who  are 
responsible  for  the  extra-marginal  increments  of  supply.  They, 

187 


PRINCIPLES  OF  ECONOMICS 

of  course,  make  no  sales  and  are  commonly  referred  to  as  ex- 
cluded sellers. 


ILLUSTRATIVE  PROBLEMS. 

1.  Suppose  the  conditions  of  supply  of  Milton's  autographs 
to  be  such  that  15  would  be  offered  if  the  price  were  $200;   13, 
if  it  were  $175;  12,  if  $150;  9,  if  $140;  8,  if  $125;  5,  if  $110;  4,  if 
$100 ;  2,  if  $90;  and  i,  if  $75. 

(a)  Make  out  this  supply  schedule  in  tabular  form. 

(b)  Make  out  a  combined  demand  and  supply  schedule  using 
the  demand  schedule  from  Problem  3  under  Demand. 

2.  Suppose  the  supply  schedule   for  cordwood  on  a  certain 
Saturday  to  be  as  'follows:    i  cord  offered  if  price  is  $4.50;  2,  if 
price  is  $4.75;  two  more,  if  $5;  three  more,  if  $5.25;  10  in  all,  if 
$5.50;  17,  if  $5.75;  and  8  more,  if  $6. 

Make  out  a  combined  demand  and  supply  schedule  for  this 
wood  using  the  demand  schedule  from  Problem  2  under  Demand. 

3.  Suppose  that  the  supply  schedule  for  silver  at  a  certain 
date  is  represented  by  the  accompanying  table,  and  answer  the 
questions  which  follow : 

(a)  Interpret  the  last  five  lines,  be- 

Prlce  Supply      ginning  at  the  last;  also  the  tenth  to  the 

cents  ooo  oz.       fifth. 

(b)  What  would  be  the  marginal  in- 
08                       J°3          crement  of  supply  if  actual  price  were 

55c?   6oc?   63c?   S^c?   52c?  6sc? 

(c)  What  would  be  the  first  extra- 
marginal  increment  of  supply  if  actual 
price  were  540?  56c?  sgc?  640?  670? 

J§  (d)     What  would  be  the  first  intra- 

gj  marginal  increment  of  supply  if  actual 

60  II2          price  were  63C?  620?  6oc?  57c?  550? 

59  loo  (e)     What-    would    be    the    'marginal 

58  100          supply  price   if   actual  price  were  67c? 

57  94          6sc?  63c?  62c?  59c?  55c? 

56  85  (f)     What  would  be  the  first  extra- 

55  85  marginal    supply    price    if    actual    price 

54  were  66c?  63c?  6ic?   59c?  55c?  52c? 

(g)  Who  would  be  the  marginal  sel- 
lers if  actual  price  were  67c?  64c?  63c? 
59c?  5<3c?  54C? 

(h)     What  would  be  the  first  intra- 

marginal  supply  price  if  actual  price  were  55c?  53>c?  52c?  59C? 
58c?  66c? 

(i)     Who  would  be  the  first  extra-marginal  sellers  if  actual 
price  were  66c?  6ic?  63c?  590?  5§c?  55'C?  520? 

138 


CHAPTER  VIII.     SUPPLY  AND   DEMAND 

(j)  Who  would  be  the  first  intra-marginal  sellers  if  actual 
price  were  550?  59c?  62c?  6ic?  6/c? 

Section  C.     The  Law  of  Single  Price. 

The  facts  just  brought  out  with  respect  to  demand  and  sup- 
ply might  perhaps  suggest  to  the  student  that  we  should  natur- 
ally expect  to  find  each  commodity  having  several  prices.  Thus, 
the  demand  schedule  for  silver  on  page  169  shows  70  thousand 
ounces  wanted  if  price  is  60  cents,  10  thousand  more  if  price 
falls  to  59  cents,  and  so  on.  That  is,  some  persons  want  as  much 
as  10  thousand,  provided  these  can  be  had  for  59  cents,  though 
if  the  price  were  60  cents,  these  persons  would  go  without.  In 
like  manner,  some  persons  stand  ready  to  take  10  thousand  more 
provided,  and  only  provided,  price  falls  to  58  cents.  And  so  on 
down  the  line.  Again,  a  similar  analysis  of  the  supply  schedule 
of  silver  appearing  on  page  182  would  show  that  supply  breaks  up 
into  many  parts,  just  as  demand  does.  That  is,  a  certain  quantity 
will  be  offered  if  price  is  50  cents,  10  thousand  more  provided, 
and  only  provided,  price  rises  to  51  cents,  10  thousand  more,  if 
price  rises  to  52  cents,  and  so  on.  Is  it  not  natural,  then,  to 
expect  that  some  silver  will  be  sold  at  60  cents,  some  at  59  cents, 
some  at  58  cents,  and  so  on?  The  answer  is  surely  a  negative 
one;  and  the  reasons  therefor  are  plain.  There  are  doubtless 
buyers  on  the  market  willing  to  give  more  than  the  price  at 
which  sales  actually  take  place;  but  the  competition  of  sellers 
to  gain  the  exceptional  profit  which  such  sales  would  secure, 
would  make  it  unnecessary  for  any  buyer  to  pay  these  higher 
prices.  On  the  other  hand,  there  are  doubtless  sellers  on  the 
market  ready  to  furnish  the  goods  at  prices  lower  than  the 
price  at  which  sales  actually  take  place;  but  the  competition  of 
buyers  to  get  the  benefit  of  these  lower  prices  would  make  it 
unnecessary  for  any  seller  to  take  such  prices.  Formulating  'the 
point  thus  brought  out,  we  have  the  following 

Principle.     The  Law  of  Single  Price. 

Broadly  speaking,  a  commodity,  can  have  but  one  price  in  the  I 
same  market  at  the  same  time. 

Note :  There  are  in  actual  life  many  exceptions  to  this,  as 
to  other,  economic  laws.  The  principle  assumes  perfectly  free 
competition,  full  knowledge  on  the  part  of  every  one  as  to  what 
is  taking  place,  and  so  on. 

189 


PRINCIPLES  OF  ECONOMICS 

Corollary  i.  The  law  of  single  price  secures  to  many  con- 
sumers a  differential  advantage  known  as  consumer's  surplus, 
i.e.,  a  quantity  of  other  utilities  which  they  can  enjoy  because  of 
the  fact  that  they  can  secure  the  one  under  consideration  at  a 
lower  price  than  the  price  which  they  would  be  willing  to  give. 

Corollary  2.  The  law  of  single  price  secures  to  many  pro- 
ducers a  differential  gain,  sometimes  called  producer's  surplus, 

Corollary  3.  The  law  of  single  price  secures  to  owners  of 
some  scarce  and  exceptionally  efficient  factor  in  production  a 
differential  gain.  In  the  case  of  land,  this  is  called  rent;  else- 
where, a  quasi-rent. 

ILLUSTRATIVE  PROBLEMS. 

1.  "On  the  Black  Friday  of  1869,  gold  was  sold  on  one  side  of 
the   room   for  $1.60   when  it  was   being  sold   on  the  other   for 
$1.35,  etc." — Sumner. 

(a)  Why  is  such  a  fact  noteworthy  from  the  economic  point 
of  view?  'iltiUJlJl 

(b)  How  was  it  to  be  explained,  do  you  suppose? 

2.  Professional  men,  especially  those  of  the  medical  profes-, 
sion,  frequently  try  to  eliminate  the  law  of  single  price  in  respect 
to  their  services. 

(a)  Why  is  it  for  the  interest  of  physicians  to  get  rid  of 
this  law? 

Ob)  Give  some  reasons  why  they  are  quite  likely  to  have 
more  or  less  success  in  carrying  out  this  policy. 

3.  The  railroads  have  struggled  very  persistently  against  the 
Federal    and    State    laws    which    prohibit    discrimination    among 
shippers,    i.    e.,   charging   different   prices    for   the   same   service. 
They  commonly  wish  to  sell  their  services  to  large  and  wealthy 
shippers  more  cheaply  than  to  smaller  and  poorer  ones. 

(a)  Why  can  it  be  for  their  interest  thus  to  get  rid  of  the 
law  of  single  price  in  just  the  opposite  way  from  that  followed 
by  physicians? 

(b)  Give  some  reasons  why  it  is  extremely  difficult  for  the 
government    to    hinder    the    railroads    from    carrying    out    their 
wishes  in  this  matter. 

Section  D.     The  Law  of  Supply  and  Demand. 

i.     With  Typical  Schedules. 

We  are  now  prepared  to  take  up  the.  actual  processes  of  price- 
determination  through  what  as  commonly  known  as  the  law  of 
supply  and  demand.  In  doing  this,  we  slhall  treat  first  the  case 
under  which  demand  and  supply  schedules  are  of  the  regular, 

190 


CHAPTER  VIII.     SUPPLY  AND   DEMAND 

symmetrical  sort  which  we  have  called  typical.     Let  us  begin  by 

placing  before  ourselves,  in 

Demand  Price  Supply      both   tabular   and   diagram- 

ooo  02.  cents  ooo  02.      matic  form,  our  typical  de- 

mand ,and  supply  schedules 

60  170          combined  into  one.     In  the 

59  1 60          taible,   the   common  price  is 

58  150          placed    in    the    middle    col- 

57  140          umn,     while     the     demands 

56  130          corresponding  to  the  several 

55    •  120          prices    appear    in    the    first 

54  no          column,    and    the    supplies 

53  loo          in  the  third.     The  diagram 

52  90          in  Figure  17  represents  the 

51  80          supply      rectangles      super- 

50  70          posed  on  those  of   demand 

in    such    a    way    that    the 

boundaries  of  the  rectangles  which  express  demand  and  supply, 
respectively,    at   any    particular    price,    coincide    as    far   as    their 

120  160 

i     I    ' — i — i — 1 — i 


.70 
80 
90 
100 
no 
120 
130 
140 
150 
160 
170 


- 

D' 
-P 
•tf 

d 

s. 

\ 

.  \ 

1           • 

, 

1                          1 

1                 1 

s'                                II    ;E1 

S                                                     :M| 

S"                                               U     :t| 

r 

r    13 

i 

i 

1  , 

i 

t 

Fig.  17. 

d 

length  will  permit.  To  make  it  easy  to  distinguish  at  a  glance 
the  demand  and  supply  rectangles,  the  right  hand  ends  of  the 
latter  are  traced  in  a  heavy  line.  From  these  data,  it  is  easy  to 
discover  how  price  is  determined.  First,  as  a  glance  at  the 
diagram  shows,  the  boundaries  of  demand  and  supply  coincide 
at  one  and  only  one  price.  Secondly,  this  one  and  only  one  price 
at  which  demand  and  supply  coincide,  is  the  one  which  must  tend 
to  prevail.  In  proving  this,  we  will  show  (i)  that  equilibrium 


191 


PRINCIPLES  OF  ECONOMICS 

among  the  forces  which  influence  prices  cannot  be  established  so 
long  as  actual  price  is  above  or  below  the  equalizing  price,  and 
(2)  such  equilibrium  is  established  when  actual  price  coincides 
with  the  equalizing  price. 

First,  then,  equilibrium  cannot  be  established  with  actual  price 
above  or  below  the  equalizing  price.  Thus,  let  us  suppose,  in  the 
first  place,  that  price  is  above,  say,  at  56c.  Could  it  remain  there? 
Surely  not.  Sellers  would  have  two  reasons  for  bidding  it  down, 
(a)  At  56c,  the  marginal  increment  of  demand — represented  by 
the  small  square  marked  M  in  the  diagram — would  disappear,  re- 
ducing total  demand  from  DM  to  D'l.  But  the  sellers  who  are 
willing  to  take  550  need  the  whole  of  DM  to  absorb  their  supply. 
They  will,  therefore,  bid  price  down  to  550  in  order  to  save  the 
marginal  increment  of  demand,  (b)  Again,  if  price  went 
to  56c,  the  first  extra-marginal  increment  of  supply — marked 
E — would  come  in.  But  sellers  at  55>c  could  not  afford  to 
permit  this;  since  their  supply  is  already  large  enough  to 
cover  the  whole  demand,  and,  if  a  new  supply  came  in,  they 
would  probably  fail  to  dispose  of  some  parts  of  their  supply. 
They  would  therefore  have  a  second  reason  for  bidding  price 
back  to  55c.  It  is  thus,  evident  that  price  could  not  remain  at 
56c.  But,  if  this  figure  were  too  high,  then  570  or  s8c  or  any- 
thing above  56c  surely  would  be  too  high ;  since  the  reasons  for 
bidding  price  back  to  55c  would  become  more  cogent  with  every 
cent  which  was  added  to  the  price.  It  follows,  therefore,  that 
price  could  not  be  above  55c. 

But,  now,  let  us  suppose  price  to  go,  for  a  moment,  below  55c, 
say,  to  54'c.  Could  this  price  stand?  Surely  not.  Buyers  who 
are  ready  to  give  5-50  would  have  two  reasons  for  bidding  it  back 
to  their  figure,  (a)  At  54C,  the  marginal  increment  of  supply 
— represented  as  M  in  our  diagram — would  be  withdrawn,  reduc- 
ing supply  from  SM  to  S'T.  But  the  55c  buyers  want  the  whole 
SM  to  satisfy  their  demand.  They  will,  therefore,  bid  actual 
price  back  to  55c  in  order  to  keep  this  marginal  increment  of 
supply  on  the  market,  (b)  Again,  if  price  went  to  54c,  even  if 
supply  did  not  fall  off,  the  first  extra-marginal  increment  of 
demand — marked  E',  in  our  diagram — would  come  in.  But 
55c  buyers  could  not  afford  to  permit  this;  since  their  own 
demand  is  large  enough  to  cover  the  existing  supply,  and,  in 
order  to  insure  getting  all  offered,  they  would  need  to  exclude 
the  new  demand  and,  hence,  would  need  to  bid  price  back  to  55c. 

192 


CHAPTER  VIII.     SUPPLY   AN'D   DEMAND 

Thus,  price  could  not  remain  at  54C.  But,  if  this  figure  is  too 
low,  53c  or  52C  or  anything  below  540  would  surely  be  too  low. 
That  is,  the  reasons  for  bidding  price  back  to  550  would  grow 
more  cogent  with  every  cent  which  was  taken  from  price.  It  fol- 
lows, then,  that  price  could  not  remain  either  above  or  below  550. 

We  have  seen  that  actual  price  could  not  be  kept  either  above 
or  below  550.  Is  there  any  reason  to  believe  that  it  could  stay 
at  5Sc, — that  equilibrium  would  be  reached  at  this  point  ?  Surely  yes. 
When  actual  price  is  resting  at  this  point,  the  two  motives  which 
might  cause  sellers  to  bid  price  down,  and  the  two  which  might 
cause  buyers  to  bid  price  up,  have  disappeared.  First,  since 
at  55c  demand  is  ,as  great  as  supply  at  55c  and  hence  as  great  as, 
or  greater  than,  supply  at  any  lower  figure,  sellers  who  are  ready 
to  sell  at  any  lower  figure  will  have  no  need  to  bid  price  down 
either  (a)  to  increase  demand  or  (b)  to  cut  down  supply.  Sec- 
ondly, since  supply  at  550  is  as  great  as  demand  at  55>c,  and  hence 
as  great  as,  or  greater  than,  demand  at  any  higher  price,  s6c 
buyers  will  have  no  need  to  bid  price  up  either  (a)  to  increase 
supply  or  (b)  to  cut  down  demand. 

It  thus  appears  that,  in  the  case  of  the  demand  and  supply 
schedules  under  consideration  anyhow,  it  is  possible  to  find  one 
price  which  is  so  situated  that,  at  all  prices  below  it,  demand  is 
excessive  and,  as  a  consequence,  all  those  prices  are  shut  out; 
which,  secondly,  is  so  situated  that,  at  all  prices  above  it,  supply 
is  excessive  and,  as  a  consequence,  those  prices  are  shut  out;  and 
wlhich,  finally,  is  so  situated  that,  at  this  price  itself,  demand  and 
supply  are  necessarily  equal,  and,  as  a  consequence,  equilibrium 
among  the  price-determining  forces  is  reached, — all  tendency  to 
change  disappears.  This  price,  therefore,  might  be  the  actual 
price.  Again,  it  is  plain  that,  in  the  case  of  these  schedules  any- 
how, there  could  be  but  one  price  which  would  fulfil  these  con- 
ditions ;  for  the  quantities  in  our  two  schedules  are  varying  in  the 
opposite  directions,  and,  hence,  having  once  coincided,  would 
thereafter  diverge  more  and  more  widely  on  either  side  of  the 
coincidence  price.  It  follows,  therefore,  that  the  particular  price 
at  which,  in  the  case  of  these  schedules  anyhow,  demand  and 
supply  are,  equal,  must  tend  to  be  the  actual  price. 

But,  now,  it  hardly  need  be  said  that  the  conclusions  reached 
from  a  study  of  the  particular  schedules  which  have  been  handled 
are  not  limited  in  their  application  to. the  case  of  those  schedules; 
for  said  schedules  are  in  all  essentials  typical.  They  are  subject 

193 


PRINCIPLES  OF  ECONOMICS 

to  the  two  principal  laws  governing  schedules,  namely,  (i)  the 
law  that  demand  schedules  vary  inversely  as  price,  and  (2)  the 
law  that  supply  schedules  vary  directly  as  price.  Like  those  which 
we  have  considered,  all  typical  schedules  would  show  demand  and 
supply  boundaries  which  intersect  at  some  price,  and  which,  hav- 
ing intersected,  thereafter  more  and  more  widely  diverge ; 
for  the  demand  boundary  of  any  pair  would  vary  inversely  as 
the  price,  while  the  supply  boundary  of  that  same  pair  would 
vary  directly  as  the  price.  It  follows,  then,  (i)  that,  given 
typical  demand  and  supply  schedules,  there  will  naturally  be  one 
price  and  but  one  at  which  demand  and  supply  are  equal,  and  (2) 
that,  under  the  free  working  of  demand  and  supply,  the  price  in 
question  must  tend  to  be  the  actual  price. 

Note:  (i)  The  preceding  discussion  has  seemingly  established 
the  general  proposition  that,  for  a  given  pair  of  demand  and 
supply  schedules  of  the  standard  type,  there  is  one  and  but  one 
price  at  which  demand  and  supply  are  equal  and  that  this  equaliz- 
ing price  must  tend  to  prevail.  If,  however,  th-e  student  gets  to 
experimenting  with  different  schedules,  he  is  quite  likely  to  run 
across  some  which  are  so  constructed  that  they  show  no  single 
price  at  which  demand  and  supply  are  equal.  Thus,  if  we  make 

a  one-step  alteration  in  one 

Demand  Price  Supply       of    our    schedules,    say    the 

ooo  0£.  cents  ooo  oz.      demand     schedule,     making 

this  to  read  60,000  ounces  at 

60  60  170          6oc,    70,000   ounces    at    59c, 

70  59  160          80,000  at  58c,  and  so  on,  we 

80  58  150          should  have  a  case  of  this 

90  57  140          sort.     At  55c,  supply  would 

ioo  56  130          be  10,000  ounces  in  excess, 

no  55  120          and    still    more    at    higher 

120  54  no          prices;  while  at  54c,  demand 

130  53  ioo          would  be   10,000   in   excess, 

140  52  90          and     still     more     at    lower 

150  51  80          prices.     (See  Figure  18,  op- 

160  50  70          posite    page.)      This    case, 

'however,    is    more    difficult 

in  seeming  than  in  reality.  In  the  actual  world,  buyers  and  sell- 
ers would  simply  reckon  prices  in  a  smaller  unit,  say 
J^c  or  *4c  or  even  *^c,  instead  of  in  ic, — e.  g.,  they 
would  make  bids  at  54^  or  54^  or  54^;  and,  in  this  way, 
the  excess  of  either  demand  or  supply  would  almost  certainly  be 
eliminated.  The  student  should  remember  taht,  in  using  the 
schedules  given  in  the  text,  he  must  not  do  this. 

(2)  The  statement  just  made  is  more  particularly  true  when 
our  schedules  are  in  general  of  the  regular  type,  that  is,  the 
type  in  which  volumes  of  demand  or  supply  vary  with  regularity, 

194 


CHAPTER  VIII.     SUPPLY  AN'D   DEMAND 

inversely  or  directly  as  price.  In  the  real  world,  as  already 
pointed  out,  demand  and  supply  schedules  are  commonly  of  less 
symmetrical  form  than  those  we  have  used;  so  that,  as  a  matter 
of  fact,  we  shall  meet  some  cases  where  demand  and  supply,  as 
we  shall  understand  the  terms,  are  never  brought  to  exact  equal- 
ity. This  is  particularly  true  when  we  are  studying  normal  prices, 
the  prices  which  tend  to  prevail  throughout  some  considerable 
period  of  time.  However,  the  failure  of  these  cases  to  show 
complete  equality  of  demand  and  supply  will  be  'more  naturally 
discussed  when  they  are  specifically  before  us  for  consideration. 


9 


60- 


55 


50- 


1 

1 

1 

r 

1 

1 

_r 

1     J 

I 

1 

i 

1 

i 

1 

i  . 

1 

i 

Rg.  18. 


(3)  The  student  should  note  that  the  equality  of  demand  and 
supply  at  a  given  price  does  not  in  itself  constitute  the  only,  or 
even  the  chief,  reason  why  that  equalizing  price  tends  to  be  the 
actual  price.  It  does,  indeed,  furnish  two  reasons  why  actual 
price  may  be  the  one  in  question.  First,  since  at  said  price  supply 
equals  demand,  buyers  have  no  longer  any  motive  for  bidding 
price  up.  Secondly,  since  demand  equals  supply,  sellers  have  no 
longer  any  motive  for  bidding  price  down.  But  this  is  not  enough. 
Though  buyers  have  no  motive,  so  long  as  supply  equals  demand, 
for  bidding  price  up,  sellers  still  wish  to  push  it  -higher  if  they 
can ;  and,  though  sellers  have  no  motive,  so  long  as  demand 
equals  supply,  for  bidding  price  down,  buyers  always  have  a 
motive  for  bringing  it  down  if  they  can.  In  consequence,  we 
need  some  force  or  forces  to  insure  in  a  positive  way  that  price 
shall  not  go  higher,  on  the  one  hand,  nor  lower,  on  the  other. 
At  this  point  we  depend,  not  on  the  equality  of  demand  and  sup- 
ply at  the  going  price,  but  on  the  inequality  of  these  elements 
at  other  prices.  That  is,  actual  price  cannot  be  as  high  as  a 
schedule  price  which  makes  demand  smaller  than  supply,  nor  as 
low  as  a  schedule  price  which  makes  supply  smaller  than  demand. 
The  proof  is  easy.  As  respects  the  case  of  demand's  being 
smaller  than  supply,  a  given  price  may  bring  this  about  either  by 
cutting  down  demand  or  by  increasing  supply.  In  either  case, 

195 


PRINCIPLES  OF  ECONOMICS 

sellers  will  certainly  bid  price  clown; — in  the  former  to  bring 
back  the  withdrawn  demand,  in  the  latter  to  exclude  the  new 
supply.  As  respects  the  case  in  which  supply  is  made  smaller 
than  demand,  a  given  price  can  bring  this  about  either  by  cutting 
down  supply  or  by  increasing  demand.  In  either  case,  buyers  will 
certainly  bid  price  up; — in  the  former  to  bring  back  the  with- 
drawn supply,  in  the  latter  to  exclude  the  new  demand.  It  is 
thus  evident  that  the  inequality  of  demand  ami  supply  at  outside 
prices  constitutes  an  essential  factor  in  driving  actual  price  to  a 
point  where  it  coincides  with  that  price  which  equates  demand 
and  supply. 

(4)  In  view  of  all  that  has  been  said,  it  should  hardly  be 
necessary  to  add  that  we  ought  not  to  say  that  price  is  determined 
by  the  relation  between  demand  and  supply,  unless  we  mean  the 
relation  between  a  demand  schedule  and  a  supply  schedule.  That 
is,  the  fixing  of  a  price  is  not  just  a  question  of  demand  and 
supply  at  the  price  which  proves  to  be  the  going  one,  but,  rather, 
is  a  question  of  demand  at  several  different  prices. 

We  'have  seen  that,  given  a  certain  pair  of  demand  and  supply 
schedules  of  the  typical  sort,  there  will  usually  be  one  and  but 
one  price  at  which  demand  and  supply  are  equal,  and  this  price 
will  be  the  one  which  tends  to  prevail.  We  have  next  to  remark 
on  the  effect  on  a  price  thus  established  of  changes  in  demand  or 
supply.  First,  supposing  demand  to  increase, — that  is,  supposing 
the  demand  schedule  to  show  increases  at  the  several  prices, — • 
what  effect  on  price  would  tend  to  appear?*  Manifestly,  we 
should  expect  some  change  in  price  under  this  new  condition, 
since  we  are  now  dealing  with  an  entirely  new  demand  schedule, 
And  what  would  that  change  be  ?  How  would  the  new  price 
differ  from  the  old  ?  Plainly  enough  it  would  be  higher ;  for  the 
natural  pull  of  demand  is  an  upward  one,  while  the  natural  pull 
of  supply  is  a  downward  one.  That  is,  we  should  now  find  the 
equilibrium  price, — the  price  which  shows  equality  of  demand 
and  supply, — higher  up  than  it  was  in  our  previous  example.  Let 
us  suppose  that  demand  has  advanced  four  steps,  that  is,  that  it 
is  now  110,000  oz.,  instead  of  70,000  oz.  at  6oc;  120,000  instead  of 
80,000  at  59c;  and  so  on.  (Demand  Schedule  D'  in  table.) 
A  glance  at  Figure  19,  in  which  the  new  demand  schedule  is  rep- 


*  If  the  increase  in  demand  were  confined  to  the  price  actually  pre- 
vailing, that  is,  if  it  did  not  show  at  higher  prices,  actual  price  would  not 
change,  though  the  present  price  would  be  rendered  unstable.  That  is, 
buyers  at  higher  prices  would  temporarily  lift  price  in  order  to  insure 
getting  their  portion  of  the  supply  ;  but,  as  soon  as  they  were  satisfied,  it 
would  drop  back. 

196 


CHAPTER  VIII.     SUPPLY   AN'D   DEMAND 

resented  by  the  line  D'D',  shows  that  the  new  price  would  neces- 
sarily be  57c;  and  that  it  must  remain  there  could  easily  be  shown 


Demand 

000   OS. 

Sch.  D" 

Sch.  D' 

Sch.D 

30 

no 

70 

40 

I2O 

80 

50 

130 

90 

60 

140 

100 

70 

150 

no 

80 

160 

120 

90 

170 

130 

TOO 

180 

140 

110 

190 

150 

120 

200 

160 

130 

210 

170 

Price 
cents 

60 
59 
58 

57 
56 
55 
54 
53 
52 
5i 
50 


Supply 

OOO   02. 

170 

160 
150 
140 
130 
1 20 
no 

100 

oo 
80 
70 


by  reasoning  similar  to  that  used  in  our  original  argument.    One 
possibly  unexpected  fact,  however,  should  be  noticed.     The  new 

0  40  80  1^0  l(|0  200  240 


60- 


55- 


1 

1        1            1 

1 

1         1        J 

1          1     f 

1          1          1 

1         lit 

1         1         1 

III          1 

1        1        1 

1     1          1 

1 

1        1        1 

1            1        1 

i 

S                                  1>"                   D 

Fig.  19. 

if 

price  would  be,  not  as  we  perhaps  might  expect,  59c,  but  only  57c ; 
that  is,  While  the  demand  schedule  had  risen  four  steps,  price 
would  have  risen  but  two.  The  reason  is  plain.  As  price  rose 
with  the  new  demand  schedule,  it  found  the  point  at  which 
demand  and  supply  came  to  equality  two  steps  up,  in  spite  of  the 
fact  that  demand  had  risen  four  steps;  because,  even  with  the  old 
supply  schedule  unchanged,  the  supply  was  steadily  increasing 


197 


PRINCIPLES  OF  ECONOMICS 

with  each  rise  in  price.  If,  now,  we  summarize  the  results  of  this 
last  analysis,  we  have  to  say  that,  if  the  demand  schedule  shows 
regular  increases  all  along  the  line,  price  will  naturally  rise, 
though  not  proportionally. 

What,  now,  would  be  the  result  if,  instead  of  increasing,  de- 
mand should  diminish,  i.  e.,  should  show  decreases  all  along  the 
line?  (Demand  Schedule  D"  in  Table.)  I  hardly  need  say  that 
the  result  would  be  strictly  analogous,  though  opposite,  to  the 
result  just  brought  out  in  the  case  of  an  increase  in  demand.* 
(i)  Price  would  decline  under  the  new  schedule.  (2)  However, 
the  fall  in  price  would  not  be  proportional  to  the  change  in  the 
demand  schedule;  since  said  decline  in  price  would  find  in  the 
old  supply  schedule  a  diminished  supply  at  the  lower  figure,  and, 
so,  demand  and  supply  would  reach  equality  in  half  as  many 
steps  as  the  demand  schedule  had  declined.  These  points  are 
plainly  brought  out  in  Figure  19,  in  which  the  line  D"D"  repre- 
sents the  new  demand  schedule.  Again  summarizing  our  results : 
If  there  takes  place  a  general  decline  in  the  demand  schedule, 
price  'will  fall,  though  not  proportionally.  Finally,  if  we  combine 
into  one  the  two  propositions  with  respect  to  demand  just  estab- 
lished, we  may  say  that  a  general  change  in  the  demand  schedule 
will  be  followed  by  a  similar,  though  not  proportional,  change  in 
the  level  of  price. 


55- 


?...«,»..    .<V>.    , 

,'f0,  , 

1^0             2pO              240  _ 

p 

i" 

5                           »' 

1 

1      '                     .  J 

1 

i 

1 

1 

i 

r     .  i 

r 

r 

r 

i 

i     r 

r 

i 

j 

i 

j     i 

j 

i       i 

,  I 

i       i 

i 

i 

i       i 

i 

\ 

i       i 

r 

i 

Rg.20 

We  have  seen  that  upward  or  downward  changes  in  the  de- 


*  As  in  the  previous  case,  a  change  in  demand  confined  to  the  market 
price  would  not  tend  to  change  that  market  price,  save  to  the  extent  of 
making  it  unstable, — causing  it  to  move  down  to  S4C>  then  back  again  to  ssc. 

198 


CHAPTER  VIII.     SUPPLY  AND   DEMAND 

m'and  schedule  will  be  followed  by  similar,  though  not  propor- 
tional, changes  in  price.  It  hardly  need  be  said  that  upward  or 
downward  changes  in  the  supply  schedule  will  usually  be  fol- 
lowed by  opposite  changes  in  price.*  Thus,  if  the  the  supply 
schedule  rises  four  steps,  as  in  Figure  20,  S'S',  (Supply  Schedule 
S'  in  table),  price  will  decline  two  steps  to  53c,  since  the  neces- 
sary equality  of  demand  and  supply  appears  at  this  point  when 
the  new  supply  schedule  is  combined  with  the  old  demand  sched- 


Demand 

000  OS. 

Price 
cents 

Supply 

000  02. 

Sch.  S 

Sch.  S'  . 

Sch.  S" 

70 

60 

170 

210 

130 

80 

59 

160 

20O 

120 

90 

58 

150 

IOO 

no 

IOO 

57 

140 

180 

IOO 

no 

56 

130 

170 

90 

120 

55 

120 

160 

80 

130 

54 

no 

150 

70 

140 

53 

IOO 

140 

60 

ISO 

52 

00 

130 

50 

160 

5i 

80 

1  20 

40 

I/O 

So 

70 

no 

30 

ule.  On  the  other  hand,  if  the  supply  schedule  declines  by  four 
steps,— S"S"  in  Figure  20,— (Supply  Schedule  S"  in  table),  price 
will  rise  two  steps  to  57c;  because  equality  of  demand  and  supply 
appears  only  at  this  point. 

We  will  now  summarize  all  the  points  made  in  the  preceding 
discussion  in  a  formal  principle  known  as  the  law  of  supply  and 
demand. 

Principle:     The  Law  of  Supply  and  Demand. 

(a)  Given  a  typical  demand  schedule  and  a  typical  supply 
schedule,  there  will  be  one,  and  but  one,  price  at  which  demand 
and  supply  arc  equal, — demand  being  in  excess  at  prices  below 
this  and  supply  being  in  excess  at  prices  above — ;  and,  since  price 
must  tend  to  rise  so  long  as  demand  is  in  excess  and  to  fall  so 
long  as  supply  is  in  excess,  actual  price  must  move  up  or  down 
until  it  coincides  with  the  one  price  at  which  demand  and  supply 
are  equal. 


*  Here,    as   before,    these    changes    must   be    general    and   not    merely   at 
the  former  price. 

IQO 


PRINCIPLES  OF  ECONOMICS 

(b)  //  there  takes  place  in  the  demand  schedule  a  general 
change  up  or  down,  a  new  price  will  be  established  through  the 
interaction  of  the  new  demand  schedule  and  the  old  supply  sched- 
ule in  the  same  way  as  the  old  price  was  established;  and  the  new 
price  will  vary  from  the  old  in  the  same  direction  as  the  new 
schedule  varies  from  the  old,  though  not  proportionally. 

(c)  //   there   takes  place   in   the  supply  schedule  a  general 
change  up  or  down,  a  new  price  will  be  established  through  the 
interaction  of  the  new  supply  schedule  and  the  old  demand  sched- 
ule in  the  same  way  that  the  old  price  was  established;  and  the 
new  price  will  vary  from  the  old  in  the  opposite  direction  from 
that  in  which  the  new  supply  schedule  varies  from  the  old,  but 
not  proportionally. 

ILLUSTRATIVE  PROBLEMS. 

1.  "The  price  can  not  long  remain  above  cost  of  produc- 
tion.    For,  so  long  as  it  is  above,  profits  will  be  exceptionally 
high;  this   fact  will  cause  production  to  increase;   as   a   result 
supply    will    become  .     ,    and   price   will     .      .      .      ." 

Fill  in  the  blanks,  using  the  Law  of  Supply  and  Demand. 

2.  "The    demand    for    wheat    was    increased    beyond    the 
capacity  of  the  best  lands  to  furnish  it,  and  so  a  new  supply 
was  brought  out  by  putting  inferior  lands  under  cultivation." 

To  make  that  reasoning  quite  complete,  one  or  two  other 
links  should  have  been  put  in  between  the  premise  and  the  con- 
clusion. Supply  those  links. 

3.  The  table  given  below  contains  a  section  from  a  hypo- 
thetical  supply   schedule    for   silver   and  the   corresponding   sec- 
tions from  five   different  demand  schedules. 

(a)  Interpret  the  supply  schedule.  (This  is  best  done  by 
beginning  at  the  lowest  prices.) 

(b)  What  would  price  tend  to  be  with  Demand  Schedule  D? 
Prove. 

(c)  Show  that  price  would  be   more  or  less  unstable  with 
each  of  the  remaining  demand  schedules. 

SUPPLY    PRICE  DEMAND 


in 
mil.  oz. 

in 
cents 

in 
mil.  oz. 

SCH.  A 

SCH.  B 

SCH.  C 

SCH.  D 

SCH.  E 

290 

59 

185 

190 

205 

217 

205 

290 

58 

190 

203 

218 

230 

218 

290 

57 

200 

218 

230 

248 

230 

260 

56 

209 

230 

245 

260 

245 

260 

55 

225 

240 

258 

275 

275 

198 

54 

230 

255 

270 

290 

290 

175 

53 

239 

275 

290 

315 

315 

175 

52 

246 

290 

310 

330 

330 

200 


CHAPTER  VIII.     SUPPLY   AND   DBMAND 

4.  Take  the  demand  supply  schedules  for  Milton's  autographs 
and  cord  wood  given  on  pages  177  and  188,  and  show  what  the 
price  in  each  case  must  tend  to  be. 

5.  "Demand  having  increased,  price  rises.  But  this  higher 
price  cuts  down  demand ;  and  so  price  comes  right  back  to  where 
it  was  in  the  first  place." 

Show  that  this  result  could  not  be  reached  in  a  normal  case. 

6.  The  high  rate  of  exchange  made  exporting  more  than 
usually  profitable.  As  a  result,  the  supply  of  cotton  for  the 

foreign  market the  price     .     .     .     .,  this  caused 

the    foreign    demand    to    .     .     .     . ,    and    so    exports    .... 
Fill  out  the  blanks,  applying  the  Law  of  Supply  and  Demand. 

2.  With    Irregular   Schedules. 

Thus  far  in  this  section,  we  have  discussed  the  determination 
of  price  through  demand  and  supply  on  the  hypothesis  that  our 
schedules  are  of  the  typical  sort,  regular  and  symmetrical.  We 
have  already  noticed,  'however,  that  actual  schedules  are  not 
always,  perhaps  not  even  usually,  of  this  character.  This  applies 
even  to  immediate  or  market  schedules,  but  is  especially  true  of 
the  schedules  dealt  with  when  we  come  to  study  normal  price. 


40 


60 


1        1        1 

3 

1                1 

~l 

1         1 

L  --i^^Wciry    £>tfr?t*r>d 

1          i 

^C 

1      i* 

\ 

*~t  —  '  1  •  l*r  Extra-Mora  Of  ~* 

1 

1 

1                    1 

1                    1 

1 

1                    1                    1 

55h     .          

Fig.2l 

i.  e.,  the  price  which  tends  to  be  established  throughout  some 
considerable  period.  As  a  matter  of  fact,  the  working  of  the 
law  of  supply  and  demand  is  not  materially  modified  in  these 
particular  cases;  and  they  show  comparatively  few  peculiarities. 
However,  it  is  desirable  to  run  over  them  briefly. 

One  of  tlhese  cases  to  which  we  will  give  a  moment's  atten- 
tion has  a  demand  schedule  of  the  regular  type  combined  with 


201 


PRINCIPLES  OF  ECONOMICS 

a  supply  schedule  in  which  the  volume  of  supply  remains  con- 
stant  throughout    a    longer    or    shorter    series    of    prices.      Such 

Demand  Price  Supply 

ooo  oz  cents  ooo  oz 


Sch.  D"          Sch.  D'  Sch.  D 

30        1 10        70        60        130 
40        120        80        59        120 

50  130  90  58  120 

60       140       ioo       57       120 

70  150  IIO  56  120 

80       160       120       55        120 
90        170        130        54        120  • 
ioo       180       140       53        120 

IIO  IQO  I5O  52  I2O 

120  2OO  l6o  51  I2O 

130          210  170          50  IIO 

a  case  is  represented  in  the  accompanying  table  and  Figure  21.  A 
glance  at  the  diagram  shows  that  the  law  of  supply  and  demand, 
as  already  given,  applies  with  little  or  no  qualification  to  this  case. 
There  is  one  price,  and  but  one,  at  which  demand  and  supply  are 
equal ;  and  that  price  must  be  the  actual  price.  We  may  note, 
however,  two  or  three  peculiarities,  (i)  Only  one  of  the  two 
reasons  why  sellers  must  bid  price  down  to  55  cents — namely 
their  need  to  hold  the  marginal  demand1 — is  now  operative.  (2) 
Only  one  of  the  two  reasons  why  buyers  must  hold  price  up  to 
55  cents — namely,  their  need  to  exclude  the  first  extra-marginal 
demand' — is  now  operative.  (3)  With  every  change  in  the  de- 
mand schedule,  there  will  now  take  place  a  change  in  price 
which  is  proportional  to  that  of  demand.  That  is,  if  the  demand 
schedule  should  move  up  or  down  a  certain  number  of  steps, 
the  price  would  move  in  the  same  direction  an  equal  number  of 
steps.  Thus,  if  our  demand  schedule  should  advance  four  steps, 
as  D'D'  in  Figure  21,  becoming  160,000  ounces  wanted  at  55 
cents;  150,000,  at  56  cents;  140,000  at  57  cents;  and  so  on,  price 
would  advance  4  cents,  that  is,  from  55  cents  to  59  cents ;  whereas, 
under  our  original  hypothesis,  price  would  have  advanced  only 
2  cents,  that  is,  from  55  cents  to  57  cents.  (Compare  Figure  21 
with  Figure  19.)  Similarly,  if  the  demand  schedule  should  de- 
cline four  steps,  as  D"D"  in  Figure  21,  the  price  would  also 

202 


CHAPTER  VIII.     SUPPLY  AND   DEMAND 


decline  four  steps;  whereas,  under  our  original  hypothesis,  price 
would  have  declined  only  two  steps. 

A  second  special  case  has  a  supply  schedule  of  the  usual  type, 
but  its  demand  schedule  shows  a  demand  which  remains  constant 
throughout  a  longer  or  shorter  series  of  prices.  To  this,  as  to  the 
preceding  case,  the  general  law  of  supply  and  demand  applies, 


Demand 
ooo  oz 


no 
1 20 
120 
1 20 
1 20 

I2O 
120 
I2O 
120 
1 2O 
130 


Price 
cents 

60 
59 

58 

57 
56 
55 
54 
53 
52 

50 


Supply 
ooo  oz 

Sch.  S 

Sdi.  S' 

Sch.  S" 

170 

210 

130 

160 

200 

I2O 

150 

190 

IIO 

140 

180 

IOO 

130 

170 

90 

120 

160 

80 

IIO 

150 

70 

IOO 

140 

00 

GO 

130 

50 

80 

120 

40 

70 

IIO 

30 

quite  fully:  there  is  one,  and  but  one,  price  at  which  demand 
and  supply  are  equal,  and  this  price  must  tend  to  prevail.   Again, 


120  lf>0  200  340 

T        i         I         •         I         l         ' 1 1 1 1 1 1 L. 


Jt' 

Sup. 

1     1 

^ 

I 

L—JJ 

__  —  f-/*r  Evtfn-plarn 

1 

1 

*t^ 

,       1 

i      i* 

J 

l         1 

^~^ 

M0ry.  Supply 

i         i 

,  1 

i         i 

1 

i        j 

i         i         i 

this  case  shows  some  peculiarities ;  and  these  are  closely  analogous 
to  those  of  the  preceding,     (i)  Only  one  of  the  two  reasons  why 


203 


PRINCIPLES  OF  ECONOMICS 

sellers  must  bid  price  down  to  55  cents — the  other  one  this  time 
— -is  operative.  (2)  Only  one  of  the  two  reasons  why  buyers 
must  bid  price  up  to  55  cents — again  the  other  one — is  operative. 
(3)  With  every  change  in  supply  there  will  now  take  place  a  pro- 
portional change  in  price.  That  is,  if  the  supply  schedule  moves 
up  four  steps,  the  price  will  move  down  four  steps ;  if  the  supply 
schedule  moves  down  four  steps,  the  price  will  move  up  four 
steps;  and  so  on;  whereas,  in  our  original  case,  a  change  in  sup- 
ply of  four  stages  caused  only  a  two-stage  change  in  price. 
(Compare  Figures  22  and  20). 

A  third  special  case,  which  deserves  a  little  fuller  treatment 
arises  when  both  the  demand  and  supply  schedules  show  constant 
figures  throughout  a  longer  or  shorter  range  of  prices.  Such 
a  case  is  represented  in  the  accompanying  table  and  diagram, 
Figure  23.  A  glance  at  either  shows  that  demand  and  supply  will 
be  equal  at  any  one  of  seven  different  prices.  This  would  seem  to 

indicate  that,  as  far  as  the 

Demand  Price  Supply      law  of  supply  and  demand    is 

ooo  oz  cents  ooo  02      concerned,    any  one  of   the 

prices    indicated    could    pre- 

no  60  140        vail.     Such  is,  of  course,  the 

120  59  130        case.     There   is   nothing   in 

120  58  120        the  action  of   either  buyers 

120  57  120        or    sellers    to    hinder    price 

120  56  120        from  stopping  at  58  cents  or 

120  55  120        57  cents  or  56  cents  or  any 

120  54  120        other    figure    down    to    52. 

120  53  1 20        The      forces      whidh      tend 

120  52  120        to      raise      price      are      ex- 

130  51  120        cess    of    demand    or    defi- 

140  50  no        ciency  of  supply;  while  those 

which   tend   to   lower    price 

are  excess  of  supply  or  deficiency  of  demand..  But,  obviously, 
none  of  these  forces  are  operative  so  long  as  demand  and  supply 
are  equal.  Under  our  present  hypothesis,  therefore,  the  particu- 
lar price  from  among  the  seven  named  which  actually  prevails 
must  be  determined  by  some  factor  or  factors  other  than  supply 
and  demand.  Buyers  and  sellers  will  come  to  the  market  ready 
to  take  any  one  of  the  prices  named;  but  buyers  will,  of  course, 

204 


CHAPTER  VIII.     SUPPLY   AND   DEMAND 


be  eager  to  have  the  lowest  of  the  series  prevail,  while  sellers 
will  be  eager  to  get  the  highest  of  the  series.     Where  the  price 


i> 


.60 


60 


55- 


50- 


Fig.  23. 


will  actually  settle  will  depend  chiefly  on  the  comparative  bar- 
gaining power  of  the  two  parties. 

ILLUSTRATIVE    PROBLEM. 

(a)  In  our  last  example  what  hinders  price  from  going  up 
to  59  cents  ? 

(b)  What  hinders  price  from  going  down  to  51  cents? 

(c)  If  demand  at  59  cents  were  changed  to   110,000  and  at 
60  cents  to  loo.ooo,  the 'rest  of  the  schedule  remaining  as  before, 
what   would   be   the   highest   price   which    could  prevail?     What 
cause  would  hinder  its  going  higher? 

(d)  Leave   the    demand    schedule    in    its  original    form,    but 
change  the  supply  schedule  so  that  at  58  cents  supply  is  130,000; 
at  59  cents,   140,600;   and  at  60  cents,   150,000,  while  the  rest  of 
the    supply   schedule    remains    unchanged.      What    would    be    the 
highest  possible  price?     Why  could  it  not  go  higher? 

(e)  Make  similar  changes  at  53  cents,  51  cents,  and  50  cents 
and  answer  the  same  questions. 

(f)  Leave    the    demand    schedule    in    its    original    form,    but 
change  the  supply   schedule  so  that  at  52  cents  supply  falls  off 
to  110,000;   at  51   cents,  to  100,000;  at  50  cents,  to  90,000,  and 
answer  these  questions.    What  would  be  the  lowest  possible  price? 
Why  could  it  not  go  lower? 

There  is  one  more  of  these  special  cases  which  we  will  remark 
on,  vi?.  the  case  where  the  supply  schedule  is  a  one-price  schedule. 
Such  a  case  is  represented  in  the  accompanying  table  and  dia- 
gram. Here,  there  is  one  price,  55  cents,  at  which  an  indefinite 
supply  is  forthcoming;  while,  at  prices  below  that,  none  whatever 
is  offered,  and,  at  prices  above,  no  increase  takes  place,  since  an 

205 


PRINCIPLES  OF  ECONOMICS 

indefinitely  great  amount  is  not  increasable.*  Under  the  condi- 
tions given,  price  is  bound  to  be  55  cents,  whatever  be  the  de- 
mand, if  the  commodity  involved  have  any  price  at  all, — i.e.,  if 


Demand 

OOO  OS 

Price 
cents 

Supply 

OOO  OZ 

Sch.  D"' 

Sch.  D" 

Sch.  D' 

Sch.  D 

150 

no 

70 

30 

60 

oof 

160 

120 

80 

40 

59 

00 

170 

130 

90 

50 

58 

00 

180 

I4O 

100 

00 

57 

00 

190 

150 

no 

70 

56 

00 

200 

160 

120 

80 

55 

00 

210 

170 

130 

90 

54 

0 

22O 

180 

140 

100 

53 

o 

230 

190 

150 

no 

52 

o 

240 

200 

160 

120 

5i 

0 

250   - 

2IO 

170 

130 

50 

0 

it  be  produced  at  all.  This  is  seen  plainly  in  the  diagram  where 
the  intersection  of  the  supply  boundary  and  the  demand  boundary 
is  at  55  cents  for  each  of  our  demand  schedules,  D,  D',  D",  D"' ; 

9  4,0  80  t          (  \2f  If 0  <?pO  [^fQ  [ 

60r- 


55- 


and  it  is  plain  that  this  price  would  be  the  point  of  intersection 
for  any  demand  schedule  whatsoever.  The  reason  is  plain  :  if 
price  were  below  this  figure,  supply  would  disappear  altogether, 

*  The   student   will   remember  that   mathematical   terms   are  not   to   be 
taken  too  literally  in  economic  discussions. 

f  This   sign  is  here  used  to  signify,   not  infinity,  but   simply   an   indefi- 
nitely large  amount. 

206 


4 

<*'                    d" 

d'"                                                    s 

1 

1        '               1 

1 

1 

r         i 

1 

i         i 

i         i         i 

1                           J 

i         i 

1         1 

i         i 

1         1 

S  L 

L,         U 

i...,           L 

H      \    Lin 

'd.'             a"           d' 

CHAPTER  VIII.     SUPPLY  AN'D   DEMAND 

and,  therefore,  buyers  would  be  obliged  to  bid  the  price  up  to 
55  cents  in  order  to  get  any  supply.  On  the  other  hand,  since 
even  at  55  cents  supply  exceeds  demand,  sellers  are  always  in 
danger  of  losing  their  market  to  rivals,  and,  hence,  must  hold 
the  price  as  low  as  possible  to  guard  against  this  contingency, 
that  is,  they  must  hold  it  as  low  as  55  cents.  Here  we  have  a 
really  important  case  where  there  is  no  price  at  which  demand 
and  supply  are  just  equal, — that  is,  supply  is  by  hypothesis  al- 
ways in  excess  of  demand  at  the  going  price.  The  case,  after 
all,  offers  no  serious  difficulty.  While  there  is  no  single  price 
at  which  demand  and  supply  are  equal,  there  is  a  pair  of  prices 
immediately  adjacent  to  each  other,  at  one  of  which  demand  is 
less  tlhan  supply,  while  at  the  other,  supply  is  infinitely  less  than 
demand' — being  zero.  Above,  the  upper  member  of  this  pair, 
actual  price  could  not  go ;  since  demand  at  the  higher  price 
would  experience  a  still  furtJher  decline,  thus  compelling  sellers 
to  bid  price  down  in  order  to  keep  the  larger  market.  On  the 
other  hand,  actual  price  could  not  go  down  to  the  second  mem- 
ber of  the  pair;  since  supply  would  then  disappear  altogether, 
compelling  buyers  to  bid  up  the  price  in  order  to  insure  getting 
any  supply  whatever.  At  bottom,  then,  this  case  is  not  so  very 
different  from  the  typical  one.  The  price  finally  reached  can- 
not be  one  at  which  demand  just  equals  supply;  but  it  must 
be  one  at  which  demand,  though  not  as  great  as  supply,  is// 
anyhow  much  greater  than  supply  at  the  next  lower  figure.  Or, 
differently  expressed,  the  actual  price,  in  this  case,  must  be  the  ; 
last  or  iozvest  of  those  prices  at  zvhich  supply  is  in  excess  of 
demand. 

Section  E.    The  Relation  of  Actual  Price  to  Demand  and 
Supply  Prices. 

We  have  seen  that,  in  general,  the  more  immediate  determi- 
nation of  price  is  effected  through  the  Law  of  Supply  and  De- 
mand. We  now  ask:  Is  it  not  possible,  even  in  dealing  with 
the  immediate  determination  of  price,  to  go  a  little  deeper? 
Can.  we  not  discover  some  element  or  factor  behind  the  equality 
of  demand  and  supply  which  is  determining,  fixing,  that  particu- 
lar price  which  has  to  be  established  in  order  to  equate  demand 
and  supply ?  An  affirmative  answer  to  this  question  is  surely 
inevitable.  It  is,  indeed,  more  or  less  evident  from  our  previous 
discussion  that  the  equality  of  demand  and  supply  at  the  going 
price  is  really  little  more  than  the  condition  which  brings  to  an 

20T 


PRINCIPLES  OF  ECONOMICS 

equilibrium  the  deeper  forces  which  are,  in  reality,  the  de- 
termining factors.  More  particularly,  we  can  scarcely  have  failed 
to  notice  that  actual  price  has  to  come  into  certain  quantitative 
relations  zvith  one  or  more  of  the  various  demand  or  supply 
prices,  i.e.,  the  prices  on  which  the  forthcoming  of  particular 
increments  of  demand  or  supply  is  conditioned.  It  is  along  this 
line  that  we  find  those  deeper  determinants  of  price  which  be- 
come useful  in  our  subsequent  study.  Accordingly,  we 
will  try  to  discover  the  relations  between  actual  price,  on  the 
one  lhand,  and  the  several  demand  and  supply  prices,  on  the 
other. 

In  carrying  out  the  study  proposed,  we  shall  find  it  conven- 
ient to  start  with  one  of  our  cases  of  irregular  schedules ;  and  we 
will  employ  for  this  purpose  that  on*e  in  which  both  demand  and 
supply  remain  unchanged  through  several  changes  in  price. 
Under  this  case,  again,  we  will  start  with  a  particular  sub-case, 
namely  one  in  which  supply  remains  constant  for  one  price  higher 
than  demand,  while  demand  remains  constant  for  one  price  lower 
than  supply.  Such  a  combined  schedule  is  represented  in  Figure 
25  and  the  accompanying  table.  A  glance  at  the  dia- 
gram, shows  that  dlemand 

Demand  Price  Supply      and     supply     are     equal     at 

ooo  02  cents  ooo  02      each       of       five       different 

prices ;  and,  since  the  price- 
So  61  150 

changing     forces     come     to 
QO  60  140  .,-1    • 

equilibrium     whenever     de- 
mand      and       supply       are 
no  58  120 

equal,     there     is     no     reas- 
on,    outside     tlhe     bargain- 
ee 56  I2O  .  r      ,,  ^ 

ing    capacity    of    the    buyer 
120  55  120 

and  seller,  why  any  one  of 

these  five  prices  should  not 
prevail.       How,     now,     are 
52  the  upper  and   lower  limits 

130  51  ioo          of  this  possible  price-varia- 

140  50  90          tion  under  the  same  sched- 

150  49  80          ule    to    be    fixed?      An    an- 

swer  to    this    question    will 

give  us  a  complete  list  of  the  different  elements  or  factors 
which  may  slhare  in  the  actual  fixing  of  price  in  any  particular 
case,  and,  so,  will  take  us  a  long  way  toward  answering  our 
main  question.  In  the  first  place,  it  is  obvious  that  the  limits 
within  which  price  can  vary  in  the  case  now  before  u?,  are  the 

208 


PRINCIPLES  OF  ECONOMICS 


el                                          S 

1                                            1 

1                                         \rl$tF-M  S 

1        :*T 

1 

\  Mary.  Dem 

i" 

i 

1         *L 

1                      ^j/$/£-//D 

1                                   1 

5                                         d 

Fig.25. 

same  as  the  limits  within  which  demand  and  supply  are  equal. 
At  58  cents,  demand  becomes  less  than  supply;  while,  at  52  cents, 
it  becomes  greater  than  supply.  In  consequence,  these  prices 
are  excluded,  as  also,  of  course,  any  above  58  cents  and  any 
below  52  cents.  But  it  is  easy  to  go  deeper  than  this.  We  have 

{)        .    . 


60- 


55- 


5C- 


already  learned  that  sellers  may  have  either  or  both  of  two 
motives  for  bidding  actual  price  down  to  a  particular  point,  viz., 
(i)  to  bring  back  a  withdrawn  demand,  and  (2)  to  exclude  a 
new  supply.  In  the  particular  case  before  us,  the  former  motive 
is  valid,  but  not  the  latter.  That  is,  sellers  have  to  hold  price 
at  57  cents  because,  if  it  went  higher,  the  marginal  demand 
would  be  withdrawn ;  they  do  not  have  to  hold  it  there  because, 
if  it  went  higher,  a  new  supply  would  be  forthcoming.  It  fol- 
lows that,  in  this  instance,  57  cents,  viewed  as  the  price  which 
is  necessary  to  bring  out  the  marginal  increment  of  demand, 
fixes  the  point  above  which  price  must  not  go.  But  57  cents, 
viewed  as  the  price  which  is  necessary  to  bring  out  the  marginal 
increment  of  demand,  is  the  marginal  demand  price.  Accord- 
ingly, we  have  in  the  marginal  demand  price  at  least  one  upper 
Htr.it  to  our  range  of  possible  pri-ce-variation. 

Let  us  turn,  now,  to  the  lower  limit  of  price-variation  for 
this  case.  At  S3  cents  we  have  equality  of  demand  and  supply 
for  the  last  time,  reading  downward ; — at  any  lower  price  de- 
mand will  be  in  excess.  This  result  buyers  must  shut  out  by 
keeping  price  up  to  53  cents.  Their  reasons  therefor  might  be 
either  to  bring  back  withdrawn  supply  or  to  exclude  new  de- 

209 


PRINCIPLES  OF  ECONOMICS 

mand.  As  a  matter  of  fact,  the  former  is  valid,  but  not  the 
latter;  the  marginal  supply  depends  upon  a  price  of  53  cents,  but 
the  first  extra-marginal  demand  would  not  come  in  till  52  cents 
was  reached.  In  this  case,  then,  the  reason  why  price  must  not 
go  below  53  cents  is  that  this  is  the  price  which  is  necessary  to 
bring  out  the  last  increment  of  supply.  But  the  price  so  char- 
acterized is  the  marginal  supply  price.  Accordingly,  we  have  at 
least  one  lozuer  limit  to  price-variation  in  the  marginal  supply 
price. 

But,  now,  let  us  make  a  slight  change  in  our  schedule,  fixing 
things  so  that  demand  will  be  constant  one  price  higher  than 
supply  and  supply  constant  one  price  lower  than  demand.  This 
joint  schedule  is  represented  in  Figure  26  and  the  accompanying 

table.    A  glance  shows  that, 

Demand  Price  Supply      as  before,  -price  may  be  any- 

ooo  oz  cents  ooo  os      thing  between  53  cents  and 

57  cents  inclusive.     But  the 

90  61  160          elements     which     determine 

TOO  60  150          the  limits  above  and  below 

no  59  140          are     different     from     those 

120  58  130          which   determined  said  lim- 

120  57  120          its  in  the  former  case.     In 

120  56  120          this    case,    the    motive    im- 

120  55  120          pelling   sellers   to   bid   price 

120  54  120          down  to  57  cents  is  not  to 

120  53  120          bring  back  a  withdrawn  de- 

130  52  120          mand,    for    there    would    be 

140  51  no          none,    but    to    exclude    th,e 

150  50  TOO          new  supply  which  would  be 

160  49  90          forthcoming  if  price  reach- 

ed 58  cents.    In  other  words, 

sellers  must  not  permit  price  to  go  to  58  cents  because  that  price 
conditions  the  coming  in  of  the  first  extra-marginal  supply. 
But  a  price  wlhich  conditions  the  coming  in  of  the  first  extra- 
marginal  supply  is  the  first  extra- marginal  supply  price.  It 
follows,  then,  that,  in  the  case  before  us,  the  first  extra-marginal 
supply  price  sets  an  upper  limit  to  actual  price,  in  the  sense  of 
a  limit  to  which  actual  price  must  not  go.  Accordingly,  com- 
bining our  two  cases,  we  say  that  the  upper  limit  of  price-varia- 
tion is.  or  may  be,  fixed  by  either  or  both  of  tivo  factors  or 
moments:  (i)  the  marginal  demand  price  and  (2)  the  first 


CHAPTER  VIII.     SUPPLY   AND   DEMAND 


extra-marginal  supply  price.     Above  the  former,  price  must  not 
go ;  to  the  latter,  price  must  not  go. 

Turning  to  the  lower  limit,  we  see  that,  as  with  our  first  sched- 
ule, that  limit  must  be  53  cents.  But  here,  again,  the  motive 
impelling  buyers  to  keep  the  price  up  is  different  from  what  it 

0                 4,0                80                 l£0  160 

I — i — i — i — I — i — i — i — L_J — i,    i    1 — i — i i     I      . 


1                   ! 

I              I 

'  ^ 

*r 

^•Afarg.  Dem. 
__•»  Afarq.  St/jo 

:  * 

|             ^\^/f£~-MD 

1                 ! 

r           i 

S                                        J> 

Fig.26. 

was  before.  With  our  first  set  of  schedules,  they  could  not  let 
price  go  below  53  cents  because  this  price  was  necessary  to  keep 
on  the  market  the  marginal  supply.  With  the  new  pair  of  sched- 
ules, they  cannot  let  actual  price  go  below  53  cents  because  the 
next  lower  price,  52  cents,  is  the  price  which  conditions  the 
forthcoming  of  the  first  extra-marginal  increment  of  demand. 
But  the  price  which  conditions  the  forthcoming  of  the  first  extra- 
marginal  increment  of  demand,  is,  by  'definition,  the  first  extra- 
marginal  demand  price.  Consequently,  actual  price  must  not  go 
down  to  the  first  extra-marginal  demand  price.  Thus,  with  the 
lower  limit  as  with  the  upper  limit,  we  have  two  possible  limit- 
ing factors  or  moments  :  namely,  (i)  the  marginal  supply  price 
and  (2)  the  first  extra-marginal  demand  price :  belozv  the  former, 
price  must  not  go:  to  the  latter,  price  must  not  go. 

The  preceding  discussion  has  shown  that  there  are  two  pos- 
sible determinants  of  each  limit  of  price-variation.  It  is  scarcely 
necessary  to  add  that  both  of  these  may  participate  in  the  fixing 
of  said  limit.  A  slight  change  in  either  of  the  two  schedules 
just  used  would  give  us  such  a  case.  That  is,  if  we  suppose 
the  constancy  of  demand  and  supply  to  terminate  at  the  same 
point  above  and  below,  price  would  be  hindered1  from  going 

211 


PRINCIPLES  OF  ECONOMICS 

higher,  both  because  it  would  then  go  above  the  marginal  de- 
mand price  and  because  it  would  go  to  the  first  extra-marginal 
supply  price;  while,  on  the  other  hand,  price  would  be  hindered 
from  going  lower,  both  because  it  would  then  go  below  the 
marginal  supply  price  and  because  it  would  then  go  to  the  first 
extra-marginal  demand  price. 

Again,  it  is  hardly  necessary  to  say  that,  if  our  limiting  de- 
terminants do  not  in  a  particular  case  fix  the  same  price,  the 
one  of  tihe  two  possible  determinants  which  is  operative  is  the 
one  which  would  fix  the  inside  price,  that  is,  the  price  which  lies 
on  the  side  toward  the  other  limit.  Thus,  in  Figure  25  the  first 
extra-marginal  supply  price  would  allow  actual  price  to  go  to- 
58  cents ;  but  the  marginal  demand  price  would  allow  it  to  reach 
only  57  cents;  and,  so,  the  latter  fixes  the  actual  limit.  On  the 
other  hand,  in  Figure  26,  the  marginal  demand  price  would  per- 
mit actual  price  to  go  up  to  58  cents ;  but  the  first  extra-marginal 
supply  price  would  permit  it  to  reach  only  57  cents;  and,  so, 
the  latter  sets  the  actual  limit.  Analogous  statements  could  be 
made  with  respect  to  the  determinants  of  the  lower  limit  in 
both  of  these  cases. 

For  our  convenience  in  making  future  references  to  the  points 
brought  out  in  the  above  discussion,  let  us  summarize  them  in  a 
formal  statement. 

Principle,  (a)  //  the  demand  and  supply  schedules  are  of 
the  regular  sort, — the  one  shotting  quantities  which  vary  inversely 
as  price,  the  other  sho'iving  quantities  which  vary  directly  as 
price, — then,  on  the  one  hand,  price  cannot  go  above  the  marginal 
demand  price  nor  up  to  the  first-extra-marginal  supply  price, 
and,  on  the  other  hand,  price  cannot  go  below  the  marginal  sup- 
ply price  nor  down  to  the  first  extra-marginal  demand  price. 

Ob)  In  any  particular  case,  both  members  of  either  the  upper 
or  the  lower  pair  of  determinants  may  concur  in  fixing  the  same 
limit,  and,  hence,  may  both  be  effective  determinants  of  price 
in  that  particular  case. 

(c)  //  both  members  of  either  pair  do  not  concur  in  fixing 
the  same  limit,  the  one  which  lies  inside,  that  is,  on  the  side 
toward  the  other  limit,  is  decisive. 

Note:  In  one  class  of  cases,  single-price  supply  schedules, 
the  marginal  supply  price  and  the  first  extra-marginal  supply  price 
necessarily  coincide : — the  marginal  increment  of  supply  and  the 
first  extra-marginal  one  are  both  forthcoming  at  that  same  price. 

212 


CHAPTER  VIII.     SUPPLY  AND   DEMAND 

In  this  case,  therefore,  we  have  to  say  that  actual  price  can  not 
go  below  nor  above  the  single  supply  price. 

Case  I. 

We  have  learned  from  the  preceding  analysis,  that,  in  laying 
down  the  principles  which  regulate  price-determination,  we  do 
not  have  to  content  ourselves  with  saying  that  actual  price  must 
remain  witihin  the  range  of  prices  at  which  supply  and  demand 
are  equal,  we  can  go  on  to  find  deeper  factors,  elements,  which 
separately  or  jointly  fix  the  limits  within  which  price  must  range, 
viz.,  the  marginal  demand  price  and  first  extra-marginal  supply 
price,  for  the  upper  limit,  and  the  marginal  supply  price  and  the 
first  extra-marginal  demand  price,  for  the  lower  limit.  Let  us 
go  on,  now,  to  see  how  these  deeper  determinants  of  actual  price 
work  out  in  the  more  important  cases  wihich  we  have  studied. 
First,  let  us  take  the  case  wherein  supply  is  fixed  while  demand 
varies  in  the  regular  way,  that  is,  inversely  as  price.  We  will 
call  this  Case  I.  Such  a  schedule  is  represented  in  Figure  27,  the  sup- 
Demand  Price  Supply 
ooo  oz  cents  ooo  oz 


60  140 

59  130 

58  120 

57  120 

50  120 

55  120 
54  120 
53  120 

52       I2O 

51  no 

50     loo 

ply  schedule  being  marked  SS  and  the  demand  schedule  now  under 
consideration  DD.  Supply  is  100,000  ounces  at  50  cents ;  becomes 
110,000  at  51  cents;  then  120,000  at  52  cents;  remains  at  tihis 
figure  through  53  cents,  54  cents,  and  so  on  up  to  58  cents; 
becomes  130,000  at  59  cents;  and  so  on.  Combining  this  supply 
schedule  with  demand  schedule  DD,  price  plainly  must  be  55 
cents,  the  only  price  at  which  demand  and  supply  are  equal. 
Which  ones,  now,  of  our  four  demand  or  supply  price-deter- 

213 


Sch.  D"" 

Sch.  D'" 

Sch.  D" 

Sch.  D' 

Sch.  D 

20 

1  20 

50 

00 

70 

30 

130 

60 

IOO 

80 

40 

140 

70 

no 

00 

50 

150 

So 

120 

IOO 

60 

160 

GO 

130 

1  10 

70 

170 

TOO 

140 

120 

80 

180 

no 

150 

130 

90 

190 

120 

160 

140 

100 

200 

130 

i/o 

150 

no 

2IO 

140 

180 

160 

120 

220 

150 

190 

170 

PRINCIPLES  OF  ECONOMICS 


minants  fixes  this  price  of  55  cents?     Is  it  the  marginal  demand 
price    or    the    first    extra-marginal    supply    price    or    both    which 


40 


<        1^0  IbO  2QQ  240 


60 


55- 


M.S. 


Fig.27 


keep  actual  price  from  going  up  to  56  cents?  Is  it  the  marginal 
supply  price  or  the  first  extra-marginal  demand  price  or  both 
which  keep  actual  price  from  going  down  to  54  cents?  As 
respects  the  first  question,  the  answer  is  plain :  the  marginal 
demand  price  stops  actual  price  from  going  up  to  56  cents;  the 
first  extra-marginal  supply  price  has  no  part  in  the  matter. 
The  marginal  demand  price  is  operative,  since  sellers  cannot 
allow  actual  price  to  y,o  above  55  cents  because  this  would 
cut  down  demand  by  the  10,000  ounces  which  came  out  only 
because  price  fell  to  55  cents.  On  the  other  hand,  the  first 
extra-marginal  supply  price  has  no  part  in  the  matter ;  for  it  is 
58  cents,  a  figure  several  points  above  the  lowest  price  which 
is  shut  out,  i.e.,  56  cents.  The  second  question,  which  of 
our  two  determinants  hinders  price  from  going  down  to  55 
cents,  is  equally  easy  to  answer.  The  first  extra-marginal  de- 
mand price  does  the  work,  while  the  marginal  supply  price  has 
no  part  in  the  matter.  The  first  extra-marginal  demand  price  is 
certainly  operative ;  since  55  cent  buyers  cannot  allow  price  to 
go  down  to  54  cents,  lest  this  price  should  bring  in  10,000 
ounces  of  new  demand.  On  the  other  hand,  the  marginal 
supply  price  has  no  part  in  the  matter;  for  it  is  too  low  to  be 
operative,  being  only  52  cents,  while  price  is  stopped  by  something 
else  from  going  down  even  to  54  cents.  In  the  case  before  us, 
therefore,  it  is  demand  prices  only  which  determine  actual  price, 
— supply  prices  do  not  directly  share  in  the  process. 

Note:    (i)   This  point,  that,  in  the  case  under  consideration, 

214 


CHAPTER  VIII.     SUPPLY  AND   DEMAND 

the  determination  of  actual  price  is  left  to  demand  prices,  may 
be  effectively  brought  out  in  another  way,  namely,  by  substitut- 
ing for  our  original  demand  schedule  one  of  the  other  demand 
schedules  represented  by  D'D'  and  D"D".  As  a  result  of  either 
of  these  changes,  price  moves  up  or  down  just  the  same  num- 
ber of  steps  as  does  the  demand  schedule,  and  each  time  coincides 
with  the  new  marginal  demand  price  and  remains  above  the 
new  first  extra-marginal  demand  price,  although  the  marginal 
and  first  extra -marginal  supply  prices  remain  all  the  time  un- 
changed,— that  is,  remain  all  the  time  52  cents  and  58  cents, 
respectively. 

(2)  This  setting  up  of  demand  prices  as  the  only  direct 
determinants  of  actual  price  must  not  be  understood  to  mean 
that  supply  prices  have  absolutely  no  part  in  the  matter.  If 
supply  remains  constant  through  only  a  short  range  of  prices, 
then  supply  prices  are  influencing  price-determination  in  the 
sense  that  they  are  in  the  background  setting  limits  to  the  range 
within  which  actual  price  can  follow  the  marginal  demand  price 
without  being  influenced  by  supply  prices.  This  comes  out 
clearly  if  we  keep  on  changing  the  demand  schedule  indefinitely. 
Thus,'  if  we  raise  our  demand  schedule  to  D"'D"'  which  is  five 
steps  above  DD,  price  does  not  advance  five  steps,  but  only 
four,  and  that  because  a  new  marginal  supply  price  has  been 
brought  out  by  the  change  and  proceeds  to  exert  its  influence 
on  price. 

From  the  above  discussion  we  have  learned  that,  in  the  case 
before  us,  price-determination  is  in  the  control  of  demand  prices, 
and.  in  particular,  that  actual  price  must  not  be  above  the 
marginal  demand  price  nor  as  low  as  the  first  extra-marginal 
demand  price.  Rut,  since  these  two  are  in  immediate  juxta- 
position, it  is  enough  to  say  that  actual  price  must  coincide  with 
the  marginal  demand  price.  Formulating  the  points  made,  we 
have  the  following : 

Principle.  //  a  particular  commodity  has  a  supply  schedule 
which  remains  constant  through  a  series  of  prices,  while  its 
demand  schedule  is  of  the  typical  variety,  wherein  demand  varies 
inversely  as  price,  and  if  the  price  at  which  demand  and  supply 
are  equal  lies  within  the  range  of  constant  supply,  actual  price 
must  tend  to  coincide  with  the  marginal  demand  price,  without 
being  influenced  b\  supply  prices. 

Case    II. 

We  have  just  considered  a  special  case  of  price-determination 
in  which  the  decisive  factor  is  demand  price, — supply  prices 
having  no  part  in  the  immediate  processes.  We  now  take  up 
certain  cases  of  just  the  opposite  kind,  that  is,  cases  in  which 

215 


PRINCIPLES  OF  ECONOMICS 

supply  prices  are  the  determining  factors,— demand  prices  being 
inoperative.  The  most  natural  one  of  these  to  introduce  the 
matter  is  perhaps  the  one  which  reverses  the  conditions  of  the 
case  we  have  just  considered,  that  is,  the  case  in  which  demand 
remains  constant  while  supply  varies  in  the  usual  way.  Sudh  a 
schedule  appears  in  the  accompanying  table.  Here  it  is  plain  that 
with  Schedule  S,  actual  price  must  be  55  cents.  But  why  ?  What 
hinders  actual  price  from  going  up  to  56  cents  or  down  to  54 
cents?  .First,  it  is  easy  to  see  that  unlike  the  pre- 
ceding case,  the  upper  limit  of  price  is  not  being  influenced  by 
marginal  demand  price— the  factor  which  determined  the  matter 
in  the  preceding  case.  For  the  marginal  demand  price  is  in  this 
case  59  cents;  so  that,  if  it  were  fixing  actual  price,  that  price 
might  go  4  cents  higher  than  the  point  which  it  actually  can 
reach.  But,  secondily,  it  is  equally  evident  that  the  upper  limit 
is  being  influenced  by  the  first  extra-marginal  supply  price. 
That  is,  actual  price  could  not  go  above  55  cents  for  the  reason 
that  it  would  bring  it  to  the  first  extra-marginal  supply  price, 
56  cents,  hence  would  let  in  a  new  supply, — a  result  which  55 
cent  sellers  must  not  permit,  since  they  need  the  whole  demand 
to  carry  off  their  supply. 

Demand      Price 
ooo  O7.        cents 


100  60 

i  ID  59 

120  58 

120  57 

120  56 

120  55 

120  54 

120  53 

120  52 

130        51 
140         50 

Turning  now  to  the  causes  which  hinder  price  from  going 
below  55  cents,  we  again  find  that  demand  prices  no  longer  play 
any  part, — supply  prices  completely  dominating  the  situation. 
That  is,  price  is  not  held  up  to  55*  cents  because  otherwise  it 
would  strike  the  first  extra-marginal  demand  price ;  for  the  first 

216 


Supply 
ooooz 

Sch.  S 

Sch.  S' 

Sch.  S" 

Sch.  S"' 

Sch.  S"" 

170 
160 

190 
180 

150 
140 

120 

no 

220 
210 

150 
140 
130 

170 
160 
150 

130 

120 

no 

100 

90 
80 

200 
100 

180 

120 
110 
100 

140 
130 

120 

100 
90 

80 

70 
60 
So 

170 

I(60 
150 

90 

80 

1  10 
100 

70 
60 

40 
30 

140 
130 

70 

00 

50 

20 

1  2O 

CHAPTER  VIII.     SUPPLY   AND   DEMAND 


extra-marginal  demand  price  is,  in  the  case  before  us,  51  cents 
only,    so    that,    if    this    factor    were    determining    the    matter, 


60- 


55 


50- 


r.r  .f.r.f  .r 


I  .  I 


I  .  I 


J  ,  I  .  i 


j  ..i  .  > 


f£-Af.D 


I          I         I 


price  would  not  be  stopped  at  55  cents  but  could  go  down 
even  to  52  cents.  Marginal  supply  price,  however,  is  setting  a 
lower  limit.  That  is,  actual  price  must  be  as  high  as  55  cents 
because  this  is  the  price  whidh  is  necessary  to  retain  the  mar- 
ginal supply. 

This  point,  that  in  the  case  before  us  only  supply  prices  are 
directly  concerned  in  price-determination, — demand  prices  having 
no  part  in  the  matter, — may  be  effectively  brought  out  by  chang- 
ing our  supply  schedule  and  noting  the  effect  on  price.  Thus, 
S'S'  represents  an  increase  in  supply  of  two  degrees,  while  S"S" 
represents  a  falling-off  of  two  degrees.  In  both  cases,  the 
marginal  supply  price  changes  as  many  steps  as  the  supply 
schedule,  and  actual  price  changes  exactly  with  said  marginal 
supply  price;  while,  on  the  other  hand,  the  marginal  demand 
price  and  the  first  extra-marginal  demand  price  remain  exactly 
the  same  as  before,  namely,  59  cents  and  51  cents  respectively. 
Actual  price,  therefore,  follows  marginal  supply  price  and  noth- 
ing else. 

Note  :  This  is  true,  of  course,  only  so  long  as  we  are  within 
that  series  of  prices  for  which  demand  is  constant.  If  the  sup- 
ply schedule  becomes  S"'S'"  or  S""S,""  supply  prices  again  come 
to  have  a  part  in  determining  price.  Further,  the  marginal  de- 
mand price  is  always  in  the  background  helping  to  fix  the 
general  limits  within  ivhicJi  actual  price  can  range. 

The  preceding  analysis  has  shown  that,  in  the  case  before  us, 
supply  prices  only,  and  two  particular  ones  of  these,  have  the 
determining  of  actual  price;  and,  since  these  two  supply  prices 

217 


PRINCIPLES  OF  ECONOMICS 

are  in  juxtaposition,  it  follows  that,  in  constructing  a  formula 
for  the  case  in  hand1,  we  might  say  either  (i)  that  actual  price 
tends  to  coincide  with  that  supply  price  which  is  just  below 
the  first  extra-marginal  supply  price  or  (2)  that  actual  price 
tends  to  coincide  with  the  marginal  supply  price.  Of  these  two 
methods  of  statement,  the  second  is  obviously  preferable  and 
gives  us  the  following: 

Principle.  //  the  schedule  shows  a  constant  demand  through 
that  part  which  includes  the  price  which  equalises  demand  and 
supply,  while  the  supply  schedule  is  of  the  typical  form,  varying 
directly  and  regularly  with  price,  then  the  actual  price  will 
necessarily  coincide  with  the  marginal  supply  price,  though  it 
may  be  quite  different  from  the  marginal  or  first  extra-marginal 
demand  prices. 

Case  III. 

A  much  more  important  case  wherein  actual  prices  are  deter- 
mined by  supply  price  without  reference  to  demand  price,  is 
furnished  by  goods  showing  a  single  supply  price.  This  case  was 
discussed  on  page  207;  and  it  was  there  shown  that  actual  price 
must  coincide  with  the  lowest  of  the  prices  at  which  supply 
exceeds  demand.  But  our  present  point  of  view  gives  us  a  much 
more  useful  formula  for  this  case.  The  lowest  of  the  prices  at 
which  supply  exceeds  demand,  and  hence  the  one  with  which 
actual  price  must  coincide,  i.  e.,  55c,  is  the  marginal  supply 
price.  Stated  more  exactly,  it  is  the  supply  price ;  since,  in  the  case 
before  us,  there  is  but  one  price  which  conditions  the  forthcom- 
ing of  supply,  and  so  the  distinction  of  marginal  supply  price  is 
not  valid.  Accordingly,  in  the  case  before  us,  actual  price  must 
coincide  with  supply  price  .anyhow.  But,  further,  this  statement 
by  itself  completely  covers  the  case, — we  can  properly  ignore 
demand  prices  altogether.  If  the  commodity  in  question  is 
bought  and  sold  at  all,  i.  e.,  if  it  has  any  price  whatever,  that 
price  will  be  one  which  coincides  with  supply  price,  whatever  be 
the  marginal  or  first  extra-marginal  demand  price.  The  truth 
of  this  proposition  follows  necessarily  from  the  conditions  in- 
volved. As  'pointed  out  on  page  212,  in  cases  of  this  sort,  the 
marginal  supply  price  and  the  first  extra-marginal  supply  price 
necessarily  coincide,  so  that  actual  price  cannot  go  below  or 
above  the  single-supply  price.  But,  obviously,  this  fact  neces- 
sarily fixes  actual  price  at  just  one  point:  it  cannot  be  different. 

218 


CHAPTER  VIII.     SUPPLY  AND   DEMAND 

But,  if  actual  price  must  coincide  with  a  particular  price  not 
derived  from  the  demand  schedule,  then  demand  prices  as  such 
cannot  share  in  'determining  said  actual  price ;  and,  if  any  one 
of  them,  e.g.,  marginal  demand  price,  does  coincide  with  actual 
price,  this  must  be  because  demand  price  has  adjusted  itself  to 
an  actual  price  already  determined  by  the  single  supply  price. 
Something  like  this  is  constantly  happening  in  the  real  world. 
Thus,  Portland  cement  is  being  put  on  the  market  at,  say,  $4  a 
barrel,  and  the  lowest  use  to  which  it  is  put  is  a  $4  use, 
thus  making  its  marginal  demand  price  $4.  Presently 
it  is  put  on  the  market  at  $3.50  a  barrel,  where- 
upon it  begins  to  be  put  to  uses  where  the  buyers  can 
afford  to  pay  just  this  sum, — and  so  its  marginal  demand  price 
becomes  $3.50.  So;  again,  its  price  falls  to  $3,  whereupon  there 
is  another  extension  of  its  use,  another  lowering  of  its  demand 
price  to  the  figure  already  determined  on  the  market.  And'  this 
process  continues  as  long  as  there  is  any  decline  in  the  single 
supply  price. 

This  point  can  be  effectively  brought  out  by  showing  that,  in 
the  case  of  constant-cost  goods,  we  can  make  a  slight  change  in 
our  demand  schedule  such  that  both  the  marginal  demand  price 
and  the  first  extra-marginal  demand  price  are  decidedly  altered 
and  yet  have  actual  price  remaining  just  where  it  was.  Thus,  in 

Demand  Price        Supply 

ooo  02.  cents       ooo  02. 


Sch.  D"" 

Sch.  D"' 

Sch.  D" 

Sch.  D' 

Sch.D 

70 

70 

70 

70 

70 

60 

00 

80 

80 

80 

80 

80 

59 

00 

80 

90 

90 

90 

90 

58 

00 

80 

90 

IOO 

IOO 

IOO 

57 

00 

80 

90 

IOO 

no 

IIO 

56 

00 

80 

90 

IOO 

no 

I2O 

55 

00 

80 

00 

IOO 

IIO 

130 

54 

o 

80 

90 

no 

130 

ISO 

52 

o 

80 

90 

IOO 

120 

I4O 

5i 

0 

80 

IOO 

120 

140 

160 

5i 

o 

00 

no 

130 

ISO 

170 

50 

0 

Figure  31  let  DD  represent  the  demand  schedule  which  is  of  the 
ordinary  sort,  while  SSS  represents  the  supply  schedule — the 
commodity  being  one  which  is  not  marketed  at  all  under  55c, 

219 


PRINCIPLES  OF  ECONOMICS 

but  will  be  supplied  in  indefinite  amount  at  550  or  above.    Plainly, 
in  this  case  price,  must  be  just  55c,  the  marginal  supply  price. 


.  .  -.  1° 


50 


But  is  not  S5c  also  the  marginal  demand  price?  Yes,  but  that 
fact  has  no  part  in  determining  price.  If  we  suppose  that  demand 
experiences  no  increase  from  56  to  53c,  making  DD'  the  demand 
schedule,  or  no  increase  from  57  to  52c,  making  DD"  the  demand 
schedule,  or  none  from  58c  to  5ic,  making  DD"'  the  demand 
schedule,  or  finally  none  from  590  to  SQC,  making  DD""  the  de- 
mand sohedule,still  actual  price  would  remain  unchanged  through- 
out our  experiment  at  just  '550,  although  the  marginal  price  had 
been  changed  to  56c,  to  57c,  to  58c,  and  to  5Qc  in  succession, 
and  tihe  first  extra-marginal  demand  price  had  been  changed  to 
53>c,  52c,  5ic,  and  5oc  in  succession.  In  short,  the  coincidence 
of  actual  price  with  the  marginal  demand  price  was  not  cause 
but  effect.  The  price  w,as  bound  to  be  5510  anyhow.  If  there 
were  any  demand  which  was  valid  only  at  55c,  it  could  be  satis- 
fied just  because  actual  price  would  become  55c;  but  it  would 
have  no  part  in  making  tihe  actual  price  55  cents. 

Putting  the  point  of  the  above  discussion  into  formal  shape, 
we  have  the  following: 

/        Principle.    //  the  schedule  of  any  commodity  is  of  the  type 
I    which  IMS  a  single  supply  price,  then  actual  price  must  tend  to  co- 
incide with  said  supply  price  without  being  affected  by  demand 
prices, — provided  always  that  actual  price  can  never  remain  above 
the  marginal  demand  price. 

220 


CHAPTER  VIII.     SUPPLY  AND   DEMAND. 

Case  IV. 

To  the  special  cases  which  have  now  been  considered,  it  would 
be  easy  to  add  several  others.  But  it  is  probable  that  we  have 
already  pushed  this  analysis  further  than  is  profitable.  We  will, 
therefore,  finish  with  it  by  returning  to  our  original  case  wherein 
both  demand  and  supply  schedules  are  of  the  typical  sort,  and 
asking :  What  have  demand  and  supply  prices  to  do  with  deter- 
mining actual  price  in  this  particular  case?  The  answer  is  easy. 
Turning  to  the  schedule  and  diagram  given  on  page  191,  a  mo- 
ment's reflection  will  convince  us  that  both  members  of  the  pair 
of  determinants  which  can  set  the  upper  limit  of  price-variation 
and  both  members  of  the  pair  which  can  set  the  lower  limit  of 
price-variation  are  operative.  That  is,  actual  price  cannot  go 
above  55c,  both  because  this  is  the  marginal  demand  price  and 
because  the  next  higher  one  is  the  first  extra-marginal  supply 
price.  So,  actual  price  cannot  be  below  55<c,  both  because  this  is 
the  marginal  supply  price  and  -because  the  next  one  lower  is  the 
first  extra-marginal  demand  price.  That  is,  in  the  case  before  us, 
actual  price  is  -bound  to  fulfil  four  conditions,  (i)  not  to  be 
above  the  marginal  demand  price,  (2)  not  to  be  below  the  marginal 
supply  price,  (3)  not  to  be  up  to  the  first  extra-marginal  supply 
price,  and  (4)  not  to  be  down  to  the  first  extra-marginal  demand 
price.  But,  since,  in  the  case  of  the  typical  demand  and  supply 
schedules,  a  price  which  fulfils  the  first  two  conditions  will  neces- 
sarily fulfil  the  third  and  fourth,  we  may  omit  the  latter  and  say 
that  actual  price  must  fulfil  the  first  two  conditions.  Putting  the 
point  brought  out  into  formal  shape,  we  have  the  following: 

Principle.  //  both  the  demand  and  supply  schedules  of  any 
commodity  are  of  the  typical  sort,  showing  a  demand  which  varies 
inversely  with  price  and  a  supply  which  varies  directly  as  price, 
then  actual  price  must  coincide  at  once  with  the  marginal  de- 
mand price  and  the  marginal  supply  pr-ice. 

Note:  If  we  keep  in  clear  consciousness  the  fact  that,  in 
coinciding  with  either  of  the  quantities  named,  price  necessarily 
coincides  with  the  other,  we  may  ignore  either  of  these  two  de- 
terminants and  say  that  actual  price  must  coincide  with  the 
marginal  demand  price,  or  that  actual  price  must  coincide  witih 
the  marginal  supply  price.  Neither  of  these  methods  of  expres- 
sion, however,  commends  itself  to  the  writer. 


221 


CHAPTER  IX. 
NORMAL  PRICE. 

In  introducing  the  last  chapter,  it  was  explained  that  our  study 
of  price-determination  was  to  be  divided  into  three  parts  ac- 
cording as  it  was  concerned  with  the  immediate,  the  inter- 
mediate, or  the  ultimate  stages  of  price-determination.  The  first 
of  these  stages  has  already  been  covered.  In  the  present  chap- 
ter, we  take  up  the  second.  The  necessity  for  a  separate  treat- 
ment of  these  two  stages  can  perhaps  be  most  easily  brought 
out  (by  means  of  an  illustration.  Something  like  20  years  ago, 
the  bicycle  was  in  process  of  evolution  as  a  means  of  locomotion. 
At  that  time,  the  price  of  any  machine  which  was  thought  worth 
buying  was  in  the  neighborhood  of  $100  to  $125.  That  this  price 
was  more  or  less  fully  the  result  of  the  natural  working  of  the 
laws  of  price  which  were  considered  in  our  last  chapter,  there 
can  be  no  question.  Anyhow,  said  price  was  doubtless  one 
which  brought  demand  and  supply  into  approximate  equality. 
It  is  equally  certain,  however,  that  the  price  in  question  was 
believed  by  all  well-informed  persons  to  be  something  quite 
temporary  in  character.  Prospective  buyers  with  lean  pocket- 
books  or  with  more  than  the  usual  amount  of  prudence  and 
patience  confidently  expected  and  waited  for  a  decided  fall  in 
price.  'The  present  price,"  said  they,  "is  plainly  abnormal;  for 
the  cost  of  producing  a  good  bicycle  is  not  far  above  $30.  Doubt- 
less for  the  time  being  various  causes  may  enable  producers  to 
hold  the  price  up  to  $100;  but  this  cannot  last  many  years 
against  the  downward  pull  of  a  $30  cost."  These  supposed  re- 
marks of  a  bicycle  buyer  of  1893  suggest  the  chief  reason  for 
distinguishing  between  the  study  of  the  immediate  processes  of 
price-determination  which  occupied  the  last  chapter  and  the  study 
of  deeper  processes  which  is  to  occupy  this  chapter.  That  is, 
our  present  problem  asks :  What  are  principles  which  are  de- 
termining this  'price  which  everyone  expects  to  be  established 
in  the  long  run — the  normal  price — ,  although  everyone  is  aware 
that,,  for  the  time  being,  a  different  price  is  being  established  by 
supply  and  demand?  Let  us  now  address  ourselves  to  the  au- 


CHAPTER  TX.     NORMAL   PRICE 

swering  of  this  question; — in  other  words,  let  us  seek  to  ascer- 
tain the  principles  governing  Normal  Price. 

What  is  meant  by  this  phrase,  "normal  price,"  is  probably  by 
this  time  fairly  evident.  However,  a  specific  statement  on  this 
point  is  desirable.  By  normal  price  we  mean  a  price  which  is 
always  tending  to  prevail  during  a  given  period  as  a  result  of  the 
action  of  those  forces  which  operate  throughout  the  period,  es- 
pecially the  larger  of  those  forces.  From  this  definition  it  may 
be  inferred  that  normal  price,  though  always  tending  to  prevail, 
seldom  if  ever  does  prevail  because  of  the  interference  of  tem- 
porary causes.  Accordingly,  normal  price  is  often  defined  as  the 
price  toward  which  actual  price  constantly  gravitates,  or  about 
which  actual  price  constantly  oscillates,  though  the  two  seldom, 
if  ever,  coincide. 

Note :  Normal  price  does  not  mean  average  price.  The  lat- 
ter is  a  mere  arithmetic  concept.  The  two  might  coincide  quanti- 
tatively ;  but  it  is  probable  that  they  seldom  do.  In  any  case, 
the  two  terms  differ  radically  in  their  meaning  or  connotation. 

Section  A.     Normal  Price  and  the  Law  of  Supply  and  Demand. 

One  of  the  first  matters  to  be  emphasized  in  connection  with 
normal  price  is  that  the  law  of  supply  and  demand  already 
presented  still  governs  the  immediate  determination  of  price.  By 
this  I  mean  that,  in  so  far  as  the  permanent  forces  have  power 
to  create  a  tendency  for  some  particular  price  to  prevail,  they 
have  this  power  because  they  have  the  power  to  determine  in 
greater  or  less  degree  the  immediate  demand  or  supply  schedule. 
Thus,  the  fact  that  a  cost  price  of  30  cents  each  for  a  particular 
wooden  chair  tends  to  establish  a  normal  price  of  30  cents  for 
that  chair,  is  to  be  explained  "by  the  fact  that  the  cost's  being 
30  cents  'has  the  power  so  to  influence  the  supply  schedule  for 
these  chairs  that,  every  time  the  price  goes  above  or  below  30 
cents,  a  tendency  is  established  to  pull  it  back  to  that  point 
under'  tlic  natural  working  of  the  Law.  of  Supply  and  Demand. 

But,  again,  it  is  to  be  noted  that  the  law  of  supply  and  demand 
dominates  normal  price  in  a  deeper  sense  than  the  one  just 
indicated.  In  the  first  place,  it  is  certain  that,  besides  the  im- 
mediate demand  and  supply  schedules  which  at  any  moment  pre- 
vail, there  are  long-time  or  normal  demand  schedules  and  long- 
time or  normal  supply  schedules  covering  the  whole  period  which 
is  under  consideration.  Thus,  if  we  suppose  the  immediate 
demand  schedule  for  silver  on  a  particular  day  in  1907  to  lhave 

223 


PRINCIPLES  OF  ECONOMICS 

been  20,000  ounces,  if  price  were  6oc;  22,000,  if  59c;  25,000,  if 
580;  and  so  on,  there  must  also  have  been  a  schedule  for  the 
whole  year  1907,  a  schedule  which  might  have  read  something 
like  this:  260,000,000  ounces  wanted,  if  price  were  6oc;  275,000,- 
ooo,  if  it  were  Sgc;  290,000,000,  if  s8c;  and  so  on.  Similarly, 
alongside  the  immediate  supply  schedule  showing  what  quanti- 
ties dealers  stood  ready  to  sell  at  the  several  different  prices  on 
that  same  day  in  1007,  there  must  also  have  been  a  supply 
schedule  for  the  whole  year,  a  long-time  schedule  on  a  much 
larger  scale  showing  what  quantities  dealers  would  have  been 
ready  to  supply  at  the  several  prices  during  the  whole  year, 
supposing  conditions  unchanged.  In  the  second  place,  it  is  not 
only  certain  that  such  normal,  long-time,  demand  and  supply 
schedules  exist,  it  must  also  be  true  that  the  price  which  is 
actually  tending  to  be  established  all  through  this  period, — tihe 
normal  price,— is  determined  by  the  relation  between  these  long- 
time or  normal  demand  and  supply  schedules.  Thus,  if  we 
suppose  that  the  schedules  for  silver  given  on  page  191,  repre- 
sented the  long  time  supply  and  demand  conditions  for  that 
metal,  rather  than  the  immediate  ones,  then  we  should  have  to 
suppose  that  the  price  which  these  schedules  would  naturally 
have  established,  that  is  55  cents,  would  have  tended  to  be  the 
normal  price  for  the  period  under  consideration;  just  as,  in  the 
example  given,  it  proved  to  be  the  price  which  tended  to  be  the 
market  price  for  the  particular  day  when  those  schedules  were 
effective.  With  these  long-time  schedules,  as  with  the  market 
schedules,  there  would  be  just  one  price  at  which  demand  and 
supply  were  equal;  and,  under  the  normal  working  of  economic 
forces,  this  one  price  would  tend  to  be  established.  It  is  certain, 
therefore,  that,  in  undertaking  our  deeper  study  of  price,  we  are 
not  leaving  behind  the  law  of  supply  and  demand,  but  merely 
bringing  out  forces  and  processes  which  lie  a  little  deeper. 

Section  B.     The  Classification  of  Commodities  from  the  Stand- 
point  of  Normal  Price. 

We  have  now  reached  a  point  wlhere  our  investigation  cannot 
be  further  developed  advantageously  except  by  dealing  with 
commodities  in  classes.  That  particular  classification  which  ex- 
perience has  shown  to  be  most  useful  for  our  present  purposes 
divides  economic  goods  into  two  main  divisions:  (i)  fixed- 
supply  goods  and  (2)  variable- supply  goods.  By  the  former  are 
meant  those  goods  which  slhow  substantially  the  same  supply 

224 


CHAPTER  IX.     NORMAL  PRICE 

all  the  time ; — either  the  amount  offered  literally  does  not  change 
throughout  the  period  under  consideration,  or  it  changes  so  slight- 
ly that,  in  view  of  the  great  volume  of  demand,  its  changes  are 
negligible, — supply  is,  in  effect,  fixed,  unchanging.*  By  variable- 
supply  goods,  on  the  other  hand,  \ve  mean  just  what  the  name 
implies;  that  is,  the  supply  shows  substantial,  material,  changes 
in  response  to  changes  in  the  price  level,  usually  increasing 
as  price  rises,  diminishing  as  price  falls,  though  sometimes 
acting  in  a  reverse  way. 

Taking  up,  first,  fixed-supply  commodities,  we  note  as  one 
of  the  most  typical  of  these  some  good  which  is 
non-producible — man  can  not  make  it — and  which  is  at  the  same 
time  substantially  indestructible — man  can  not  destroy  it  or  any- 
how, acting  normally,  will  not.  Among  the  most  important 
goods  of  this  class  are  the  uses  of  land  or  land  itself.  Within 
the  area  of  any  city  there  are  just  so  many  sites  of  a  particular 
grade.  Broadly  speaking,  no  human  action  can  increase  or  dimin- 
ish their  number.  In  the  long  run,  they  will  all  be  offered  for 
rent.  In  the  long  run,  therefore,  the  supply  at  the  best  price 
which  can  be  had  will  be  the  whole  number  existing,  say  10. 
That  is,  owners  will  see  that  all  the  sites  are  rented  (remember 
that  there  is  supposed  to  be  competition)  even  if  they  have  to 
take  $1  a  year.  Accordingly,  a  section  of  the  ultimate  supply 
schedule  for  these  sites  will  run  as  follows :  10  offered  at  $2,000 ; 
10  offered  at  $1,900;  10  at  $1,800;  10  at  $1,700;  10  at  $1,600;  10 
at  $1,500;  and  so  on. 

Another  sort  of  fixed-supply  good  is  something  produced 
by  persons  who  are  no  longer  living,  e.  g.,  pictures  by 
Raphael,  autographs  of  Milton,  etc.  The  ultimate  supply  schedule 
of  such  a  commodity  would  obviously  be  similar  in  form  to  the 
one  just  given;  i.  e.,  the  supply  figure  would  include  the  total 
stock  and  so  would  be  the  same  for  every  price. 

But  producible  goods  may  also  furnish  us  cases  of  fixed^- 
supply  goods.  Thus,  if  a  certain  article,  e.  g.,  a  hat,  goes  out  of 
style  while  there  is  still  a  considerable  stock  in  existence,  then 
all  of  this  stock  inevitably  passes  into  the  status  of  supply;  and 
the  supply  schedule  shows  the  same  figure  at  every  price.  Thus, 
if  there  were  10,000  of  such  hats,  the  supply  schedule  would  run : 
10m  offered  at  $5;  10m  offered  at  $4.50;  10m  at  $4;  10m  at 
$3.50 ;  10m  at  $3 ;  and  so  on. 


*  This  case  will  be  explained  more  fully  in  a  moment. 

223 


PRINCIPLES  OF  ECONOMICS 

Producible  goods  furnish  another  case  of  fixed-supply  goods, 
if  we  are  seeking  a  formula  for  the  normal  value  of  some  periodi- 
cally produced  commodity,  e.  g.,  wheat,  for  the  interval  between 
two  harvests.  Here  substantially  the  whole  stock  is  bound  to  be 
disposed  of  during  the  period  and  so  is  bound  to  pass  into  the 
status  of  supply.  Hence  the  supply  schedule  for  the  period  as  a 
whole  would  run  (supposing  2  billions  to  be  the  .output)  2  bil. 
offered  at  $1.50;  2  bil.  at  $1.45;  2  bil.  at  $1.40;  2  bil.  at  $1.35; 
and  so  on. 

But  producible  goods  may  also  furnish  us  cases  of  fixed- 
supply  in  certain  products  the  annual  output  of  which  is  sub- 
stantially fixed,  in  that  because  of  the  intensity  of  demand,  on  the 
one  hand,  and  our  very  limited  capacity  to  produce  the  commod- 
ity involved,  on  the  ether  hand,  production  is  bound  to  be  car- 
ried to  a  point  beyond  ivhich  no  appreciable  addition  to  output  is 
possible.  As  it  sounds  rather  paradoxical  to  call  any  case  of 
producible  goods  one  of  fixed-supply,  and  as  the  matter  is  of 
theoretic  importance,  we  will  consider  this  case  somewihat  care- 
fully. First,  let  us  suppose  that  there  is  a  certain  very  greatly 
esteemed  brand  of  tea  which  can  be  raised  only  on  a  very  small 
tract  of  ground  situated  in  one  of  the  provinces  of  China;  and 
let  us  suppose  that  the  output  schedule  of  this  brand  of  tea  for 
an  ordinary  year  is  as  represented  in  the  accompanying  table. — 
that  is,  (i)  at  costs  under  50  cents,  no  tea  will  be  produced; 
(2)  while  cost  ranges  from  50  cents  to  $2,  output  will  show 
material  increases  with  every  rise  in  price;  and  (3)  after  the 
$2  point  has  been  passed,  though  increases  take  place,  they  are 
so  small  as  to  be  practically  negligible.  Given  such  a  schedule,  it 
is  plain  that  the  proper  classification  of  tJhe  commodity  involved 
will  depend  on  wliat  part  of  this  schedule  we  are  interested  in. 
If  our  interest  is  for  a  good  reason  limited  to  the  range  from 
50  cents  to  $2,  we  should  properly  describe  this  tea  as  an  in- 
creasing-cost commodity.  If,  on  the  other  hand,  we  are  con- 
cerned with  the  range  from  $2  on,  we  should  properly  treat 
t'his  tea  as  a  constant-cost  commodity.  But  what,  now,  determines 
in  what  part  of  this  schedule  our  interest  really  lies?  The  an- 
swer surely  is  that  this  is  all  a  question  of  the  volume  of  demand. 
If  the  demand  schedule  were  correctly  represented  by  Schedule 
D'  in  our  table  (D'D'  in  the  diagram),  our  interest  would  be 
entirely  in  the  range  from  50  cents  to  $2,— since  the  price  whic'h 
would  tend  to  prevail  would  lie  within  this  range;  and,  hence, 
the  tea  would  properly  be  classified  as  an  increasing-cost  com- 

226 


CHAPTER  IX.     NORMAL   PRICE 


modity.     On  the  other  hand,  if  the  demand  schedule  were  cor- 
rectly represented  by  Schedule  D  in  our  table    (DD  in  the  dia- 


Tea. 


Demand 


Sch.  D 

Sdi.  D 

pounds 

ooo  Ibs 

o 

3 

0 

5 

o 

6 

0 

8 

0 

10 

0 

12 

o 

13 

0 

IS 

0 

18 

0 

25 

5 

40 

50 

60 

500 

100 

1,000 

120 

2,000 

160 

4,500 

180 

6,000 

200 

7,000 

500 

8,000 

700 

9,000 

1,500 

12,000 

3,000 

20,000 

10,000 

50,000 

15,000 

Price 

$ 

500. 

450. 
400. 
350. 
300. 
250. 

200. 

150. 

100. 

50. 

25- 

IO. 

5- 
4- 
3- 
2.50 

2. 

1-75 

1.50 

1.25 

i. 

•75 

•50 


Supply 
Ibs 

11,683-888 

11,683.885 

11,683.88 

11,683.87 

11,683-85 

11,683.8 

11,683-5 
11,683. 
11,682. 
1 1, 680. 

n,675. 
11,650. 
1 1, 600. 
11,500. 
ii,35o. 
11,100. 
10,800. 
10,500. 

9,900. 

9,000. 

7,7oo. 

6,000. 

4,000. 


gram),  our  interest  would  be  entirely  in  the  range  above  $2, — • 
since  the  price  which  would  tend  to  prevail  lies  within  this 
range — ;  and,  hence,  under  this  second  hypothesis  the  tea  would 
properly  be  classified  as  a  constant-cost  commodity. 

Note(i)  :  The  contrast  between  the  two  'hypotheses  is  striking- 
ly brought  out  by  a  comparison  of  the  two  diagrams  appearing  on 
the  next  page.  In  Figure  i,  we  have  a  diagram  showing  only 
the  lower  part  of  our  supply  schedule  combined  with  a  very 
modest  demand  schedule  (D'  D'  of  our  table), — the  price  scale 
having  a  large  unit.  Under  these  conditions,  the  supply  boundary 
is  of  the  typical  sort,  moving  to  the  right  as  it  moves  upward, — • 

227 


PRINCIPLES  OF  ECONOMICS 


i.  e.,  the  supply  schedule  is  an  increasing-cost  schedule  and  the 
supply  price  surely  plays  a  part  in  determining  actual  price. 
In  Figure  2,  on  the  other  hand,  we  have  a  diagram  showing  a 
much  larger  portion  of  the  supply  schedule  combined  with  a 
demiand  schedule  in  which  the  quantities  are  very  much  larger, 
for  the  same  prices,  than  before, — the  price  scale  unit  being 
much  smaller.  Here  the  important  part  of  the  supply  boundary 
is  substantially  vertical  as  in  Figure  — ,  Page  — ,  showing  tha't 
the  supply  schedule  is  in  effect  one  of  the  fixed-supply  variety. 
Putting  the  results  of  this  discussion  into  general  terms,  we  may 
say  that,  if,  in  the  case  of  a  particular  commodity,  the  conditions 
of  production  are  such  that,  after  a  certain  point  has  been  reach- 
ed., only  very  insignificant  additions  to  output  can  be  made,  and 
if  the  demand  for  that  commodity  at  prices  corresponding  to 
those  costs  under  which  any  considerable  output  can  be  produced 
is  far  in  excess  of  possible  output,  then  said  commodity,  though 
producible,  is  properly  described  as  a  fixed-supply  commodity. 


Y  .  .  .  1 


.? 


Jft 


20( 

ITS 
ISO 
125- 

IOC 
.75 

.50 


Note  (2)  :  Just  how  far  this  imaginary  case  represents  actual 
cases  is  not  easy  to  determine.  Most  economists  probably  would 
hold  that  it  applies  to  only  a  comparatively  small  number  of  rare 
products  such  as  the  more  valuable  gems,  special  brands  of  wine, 
special  brands  of  tobacco,  the  very  rare  metals,  etc.  On  the 
other  hand,  one  of  the  most  eminent  writers  of  an  important 
school  of  economists,  the  Austrian  school,  contends  that  an 
illustration  like  this  would  represent  the  case  of  substantially  all 
commodities;  and  he  makes  this  hypothesis  the  basis  of  a  special 

228 


CHAPTER  IX.     NORMAL   PRICE 

theory  of  value   (price)  which  makes  all  values  (prices)   depend 
finally  upon  marginal  utility. 

Turning  now  to  variable-supply  goods,  we  distinguish  two 
principal  sub-classes:  (i)  constant-cost  goods  and  (2)  increas- 
ing-cost goods.  By  constant-cost  goods,  we  mean  producible 
goods  of  such  a  nature  that  we  can  increase  almost  indefinitely  I 
the  output  of  those  goods  without  increasing  the  cost  of  pro-  ( 
duction.  Such  a  description  is  of  course  not  quite  true  of  any 
commodity  one  might  mention.  But,  as  already  pointed  out,  it  is 
substantially  true  of  goods  like  the  wooden  chair  which  was 
used  for  illustration  in  a  former  connection,  page  122.  So  long 
as  the  output  wanted  was  greater  than  500,000  units  and  less 
than  5,000,000,  the  cost  of  producing  these  chairs  did  not  change ; 


p 


3.0C- 


25C- 


20C- 


150- 


(00 


50 


Fig.2 


and,  since  this  range  of  output  allows  for  a  very  great  variation 
in  demand,  this  constancy  of  cost  was  a  really  vital  matter, — 
the  chair  was  in  effect,  virtually,  a  constant-cost  commodity. 
Constant-cost  goods  plainly  correspond  to  what  we  called  in  the 
last  chapter  single-supply-price  goods;  that  is,  goods  the  supply 
schedule  of  which  shows  one  price  at  which  an  indefinite  amount 
will  be  furnished,  while  at  prices  below  that  figure  none  what- 
ever is  forthcoming,  and,  at  prices  above,  there  is  no  increase, 


229 


PRINCIPLES  OF  ECONOMICS 

because  the  amount  wlhich  will  be  furnished  at  the  first  price 
named  is  by  hypothesis  indefinitely  large.  It  follows  that  the  sched- 
ules and  diagrams  used  for  those  single-supply-price  goods  are 
readily  applicable  to  this  case  of  constant-cost  goods.  By  increas- 
ing-cost goods  we  of  course  mean  goods  the  marginal  cost  of 
which  increases  as  the  output  is  increased.  This  class  of  goods  is 
well  represented  by  such  products  as  silver,  copper,  wheat,  cotton, 
and  so  on;  and  the  schedules  for  goods  of  this  sort  will  be 
naturally  represented  by  the  silver  schedule  which  we  have 
employed  so  extensively  in  previous  discussions. 


Section  C.     Normal  Schedules. 

It  was  explained  in  Section  A  that  the  causes  which  in  the 
long  run  determine  normal  price  act  through  the  same  principles 
of  supply  and  demand  which  have  already  been  considered  in 
the  preceding  chapter,  and  that  we  have  long-time  or  normal 
supply  schedules  and  demand  schedules,  just  as  we  have  im- 
mediate or  market  supply  schedules  and  demand  schedules.  Ac- 
cordingly, we  must  prepare  the  way  for  our  study  of  the  theory 
of  normal  price  by  making  a  brief  investigation  into  these  normal 
supply  and  normal  demand  schedules. 

I.     Normal  Supply  Schedules. 

In  the  case  of  supply  schedules,  our  present  task  has  been  in 
a  measure  anticipated  in  that  the  classification  of  goods  which 
is  to  be  used  in  our  study  of  normal  price,  and  which  has 
already  been  explained,  is  based  upon  the. nature  of  the  supply 
schedules  of  those  goods.  Thus,  our  first  main  division  consists 
of  goods  which  show  a  constant  or  fixed  supply,  while  our  second 
main  division  consists  of  goods  which  show  variations  in  supply. 
There  are  left,  however,  two  or  three  matters  which  deserve 
special  comment.  Taking  up  first  the  case  of  fixed-supply  goods, 
it  is  obvious  that  the  principle  of  elasticity  usually  applicable  to 
supply  schedules  has  here  no  validity.  That  is,  supply  does  not 
increase  as  price  rises,  or  diminish  as  price  falls ;  for,  by  hypothe- 
sis, supply  remains  constant  throughout  the  whole  series  of  prices. 
Again,  the  distinction  between  supply  and  stock  which  applies 
to  many  other  types  of  goods  disappears  in  this  particular  case. 
Supply,  the  student  will  remember,  means  the  amount  actually 
offered  for  sale;  wihile  stock  means  the  total  amount  in  existence 
which  might  be  offered  for  sale.  But,  since  in  the  long  run  the 

230 


CHAPTER  IX.     NORMAL   PRICE 

total  stock  will  be  marketed,  that  is,  will  all  pass  over  into  sup- 
ply, we  understand  by  supply,  when  studying  normal  price,  the 
total  stock.  Another  peculiarity  of  the  supply  schedule  of  fixed- 
supply  goods  which  is  of  much  importance  is  that  these  schedules 
show  no  supply  prices  in  the  strict  sense.  That  is,  there  are  no 
prices  on  which  the  forthcoming  of  supply  is  conditioned: — the 
supply  will  be  so  and  so  whatever  the  price. 

Let  us  turn,  now,  to  tlhe  long-time  or  normal  supply  schedules 
of  the  different  classes  of  variable-supply  goods,  beginning  with 
the  first  sub-class  of  this  division,  that  is,  constant-cost  goods. 
The  first  point  to  be  remarked  here  is  that  the  supply  schedules 
of  these  goods  are  of  the  type  described  in  the  preceding  chapter 
as  a  single-price  supply  schedule,  that  is,  a  supply  schedule  of  such 
a  character  that,  at  one  particular  price,  an  indefinitely  large  amount 
is  offered  for  sale,  while,  at  figures  below  that  price,  none  is 
supplied,  and,  at  figures  above,  the  same  indefinitely  large  amount 
is  offered.  The  proof  of  this  proposition,  that  constant-cost 
goods  have  single-price  supply  schedules,  is  not  difficult.  Since 
by  hypothesis  an  indefinitely  large  amount  can  be  produced  at  the 
cost  named,  producers  will  offer  an  indefinitely  large  amount  at 
this  price;  for  the  larger  their  output  the  greater  the  profits  which 
each  producer  would  derive  therefrom.  Further,  no  more  will 
be  offered  at  higher  prices,  since  an  indefinitely  large  amount  is 
'thereby  declared  to  be  non-increasable.  On  the  other  hand,  if 
price  were  to  go  below  this  constant  cost,  producers  would  lose; 
and.  hence,  supply  will  be  zero  at  prices  below  this  constant- 
cost.  Accordingly,  there  will  be  an  indefinite  amount  offered  at 
one  particular  price,  no  more  at  prices  above  such  particular 
price,  and  none  at  all  at  prices  below.  That  is,  the  supply 
schedule  of  the  sort  of  commodity  in  question  will  necessarily 
be  a  single-price  supply  schedule. 

/  A  second  point  with  respect  to  the  supply  schedule  of  this 
/class  of  goods,  which,  although  plainly  implied  in  the  preceding 
discussion,  needs  to  be  remarked  upon  because  of  its  great 
importance,  is  that  the  factor  or  element  which  is  in  the  back- 
ground determining  the  supply  price  of  commodities  of  this  class, 
that  is,  the  price  which  conditions  the  forthcoming  of  supply,  is 
the  cost*  of  producing  said  commodity.  In  other  words,  the 

*  As  explained  in  Chapter  -z,  page  53,  we  understand  by  cost  what  we 
earlier  called  entrepreneur's  cost,  that  is  (i)  the  money  outlay  of  the 
entrepreneur,  (2)  the  money  value  of  those  contributions  made  by  the 
entrepreneur  which  could  be  bought  on  the  open  market,  and  (3)  the 
money  expression  of  such  contributions  as  the  entrepreneur  only  could 
make, — profit  in  the  narrower  sense. 

231 


PRINCIPLES  OF  ECONOMICS 

particular  price  which  constitutes  the  one  price  of  these  single- 
price  schedules  is  zvhat  it  is  because  the  cost  of  production  is 
what  it  is  It  follows  that,  if  we  find  that  the  supply  price  plays 
any  important  part  in  determining  normal  price  for  this  class 
of  goods,  we  therefore  also  necessarily  find  that  cost  of  pro- 
duction plays  this  same  part.  Whenever,  in  short,  we  have  a 
proposition  affirming  a  particular  relation  between  normal  price 
and  supply  price,  we  can  substitute  in  such  proposition  for  the 
phrase  "supply  price"  the  other  phrase  "cost  of  production." 

Passing  now  to  tihe  second  sub-class  of  variable-supply  goods, 
that  is  increasing-cost  goods,  we  remark  first  that  the  normal  sup- 
ply schedule  of  said  class  of  goods  will  be,  in  general,  an  increas- 
ing-price schedule,  that  is,  increases  in  the  amount  offered 
will  involve  increases  in  the  price  at  which  offerings  are  made. 
The  proof  is  not  difficult.  In  the  first  place,  the  supply  price  for 
any  given  volume  of  supply  will  inevitably  be  the  marginal  cost 
of  producing  that  volume  of  supply, — cost  being  taken,  remem- 
ber, to  include  the  usual  profits  to  the  producer.  Price  could  not 
be  less  than  this  marginal  cost;  since,  in  the  long  run  surely,  pro- 
ducers would  not  offer  goods  for  sale  at  a  price  which  made 
them  lose  money  if  only  on  the  marginal  portion  of  the  output. 
On  the  other  hand,  supply  price  could  not  in  the  long  run  be 
(higher  than  this  marginal  cost;  since,  although  producers  would 
always  be  glad  to  get  a  price  higher  than  their  cost,  they  will, 
after  all,  stand  ready  to  supply  the  commodity  at  a  price  as  low 
as  cost,  if  no  better  price  is  offered;  and  this  is  what  we  mean  by 
Auprily  pHn—  that  is,  they  are  the  prices  on  which  are  conditioned 
/  the  forthcoming  of  supply.  But,  again,  it  is  a  plain  corollary 
from  the  point  just  made,  that,  if  the  producer  is  obliged  to 
incur  a  greater  cost  in  order  to  increase  his  output,  then,  when 
called  on  to  do  this,  he  surely  will  make  a  corresponding  increase 
in  his  supply  price,  that  is,  the  price  on  which  Ihis  offerings  are 
conditioned:  since  otherwise  his  supply  price  would  be  less  than 
the  marginal  cost  of  production  which,  as  just  seen,  is  impossible. 
That  is,  as  affirmed  above,  the  supply  schedule  of  an  increasing- 
cost  commodity  will  be  an  increasing-price  schedule. 

We  have  just  seen  that  increasing-cost  goods  have  supply 
schedules  which  belong  to  the  class  characterized  in  the  last 
chapter  as  increasing-price  supply  schedules.  A  second  point  to 
be  made  of  much  importance  is  that  the  supply  schedules  of  goods 
of  this  class  are  also  of  the  kind  which  we  earlier  called!  typical, 

232 


CHAPTER  -IX.     NORMAL   PRICE 

that  is.  over  a  wide  range  of  prices,  these  schedules  show  fairly 
uniform  changes  in  output  with  substantially  every  material 
change  in  price ;  in  other  words,  they  are  highly  regular  and 
symmetrical.  This  is  inevitable  from  the  conditions  of  produc- 
tion. When  we  consider  that  the  natural  factor  in  production, 
the  land,  varies  greatly  with  respect  to  natural  fertility  and 
advantage  of  situation,  and  that  individuals  are  of  all  degrees 
of  efficiency,  it  is  plain  that  costs  of  production  for  goods  of  this 
class  will  be  of  almost  infinite  variety.  This,  of  course,  will 
make  the  supply  prices,  that  is,  the  prices  on  which  the  forth- 
coming of  supply  is  conditioned,  equally  diverse. 

A  third  point  to  be  made  with  respect  to  the  supply  schedules 
of  this  class  of  goods  has  already  been  brought  out  in  making 
our  first  point.  It  is  this.  The  marginal  cost  of  production  is 
the  factor  or  element  behind  the  scenes  which  determines  the 
supply  price  for  any  particular  volume  of  the  commodity  in 
question.  Thus,  if  two  billions  bushels  of  wheat  will  in  the 
long  run  be  offered  if  price  is  8oc;  two  billions  one  hundred  mil- 
lions if  price,  is  85c;  two  billions  two  hundred  millions  if  price 
is  px>c;  and  so  on,  this  will  be  true,  because  the  marginal  cost  of 
producing  two  billions  is  8oc;  thait  of  producing  two  billions 
one  ihundred  millions  is  S^c;  and  so  on.  In  other  words,  the 
supply  prices  of  a  normal  schedule  oi  a  commodity  of  this  class 
are  merely  so  many  different  marginal  costs: — the  schedule  it- 
self may  be  interpreted  either  as  a  supply  schedule  or  as  an  out- 
put-cost schedule,  that  is,  a  schedule  showing  just  how  much  of 
the  commodity  in  question  could  be  produced  at  a  marginal  cost 
equal  to  each  of  a  series  of  prices.  It  follows  from  tine  above 
that,  whatever  we  can  say  about  the  relation  between  the  normal 
price  of  a  commodity  of  the  class  before  us  and  one  or  more 
of  its  supply  prices,  we  can  with  equal  correctness  affirm  with 
respect  to  the  relation  between  said  normal  price  and  one  or  more 
of  the  costs  of  producing  said  commodity.  That  is,  in  any  for- 
mula containing  the  phrase  "marginal  supply  price"  we  can 
properly  substitute  the  plhrase  "marginal  cost  of  production." 

2.     Normal   Demand   Schedules. 

In  analyzing  normal  demand  schedules,  our  first  need  is  to 
consider  the  deeper  factor  or  element  which  lies  behind  demand 
prices;  for  there  is  no  anticipation  of  this  in  our  classification  of 
goods,  as  there  was  in  the  case  of  supply  schedules.  What,  then, 

233 


PRINCIPLES  OF  ECONOMICS 

is  tihe  factor  which  determines  the  prices  at  which  buyers  in 
the  long  run  stand  ready  to  buy  goods,  in  the  same  way  that 
cost  determines  the  prices  at  which  sellers  stand  ready  to  sell 
goods?  In  answering  this  question,  it  is  necessary  that  we 
should  go  to  the  schedule  of  the  individual  buyer  and  ask  our- 
selves what  motive  or  motives  finally  determine  his  conduct. 
For.  obviously,  tihe  general  or  social  schedules  with  which  we  have 
to  deal  are  composites  or  aggregates  made  up  by  adding  together 
the  figures  of  numerous  individual  schedules.  Thus,  if  we  say 
that,  according  to  the  general  demand  schedule  for  silver,  180,- 
000,000  ounces  are  wanted  if  price  is  55c;  190,000,000  if  price  is 
S4c;  and  so  on,  we  mean  that,  if  the  different  amounts  of  demand 
at  55c  from  the  schedules  of  all  the  different  buyers  of  silver  be 
added  together,  their  sum  will  be  180,000,000  ounces;  if  the 
different  amounts  of  demand  at  54c  from  the  schedules  of  all  the 
different  buyers  be  added  together,  their  sum  will  be  190,000,000; 
and  so  on.  We  proceed,  therefore,  to  consider  the  normal 
demand  schedules  of  the  individual.* 

First,  then,  it  is  to  be  remarked  that  the  prices  appearing 
in  the  demand  schedules  of  the  individual  are  his  money  esti- 
mates of  the  importance,  significance,  which  the  goods  in  ques- 
tion have  for  him.  Thus,  if  a  given  householder  stands  ready 
to  buy  10  pecks  of  apples  if  the  price  is  5oc  a  peck,  this  surely 
means  that  in  his  opinion  10  pecks  of  apples  have  a  significance 
or  importance  to  him  represented  by  $5.  Doubtless  this  esti- 
mate lacks  the  precision  which  would  be  required  in  measuring 
the  structural  unit  of  a  building.  But  it  is  nevertheless  very 
real  ami  quite  sufficiently  precise  for  the  purposes  of  our  house- 
holder. The  fact  that  he  decides  in  favor  of  the  apples  rather 
than  putting  all  or  some  of  the  $5  to  other  uses  shows  con- 


*  It  hardly  ought  to  be  necessary  to  say  that,  in  talking  about  the 
demand  schedules  of  the  individual,  we  have  no  intention  of  implying  that 
these  schedules  are  made  up  independently  of  social  forces.  There  can  be 
no  doubt — there  never  has  been  any  doubt — that  the  standards,  ideals, 
tastes,  wants  of  any  particular  individual  and,  therefore,  the  valuations 
which  such  individual  puts  upon  goods,  are  in  a  very  great  measure  the 
creation  of  the  community  in  which  he  lives, — the  results  of  education, 
example,  and  so  on.  We  are  born  into  the  family,  into  society,  into  the 
state ;  and  our  notions,  our  ideals,  are  never  formed  independently  of  these 
groups  in  which  we  live.  But  there  is  no  inconsistency  whatever  between 
adherence  to  this  last  doctrine  even  in  its  most  extreme  form,  and  the 
affirmation  that  the  demand  schedules  of  the  market  are  composites  made 
up  by  adding  together  the  demand  schedules  of  individuals.  For,  however 
large  may  be  the  share  of  environment  forces,  social  forces,  in  the  determin- 
ation of  our  tastes,  ideals,  wants, — these  social  forces  must  express  them- 
selves through  the  demand  of  the  individual.  Goods  are  purchased,  not  by 
the  group  will,  nor  by  the  group  ideal,  but  bv  concrete  individuals. 

234 


CHAPTER  IX.     NORMAL   PRICE 

clnsively  that  he  has  made  some  estimate  of  this  kind.  In  short, 
reasonable  economic  conduct  at  any  point — the  reasonable  utiliza- 
tion of  any  sort  of  an  income — would  be  impossible,  were  we  not 
constantly  making  estimates  of  the  kind  indicated.  The  illustra- 
tion just  usedi — the  householder  and  the  apples — was  one  involv- 
ing consumption  goods.  P>ut  substantially  the  same  proposition 
could  be  made  with  respect  to  a  manufacturer  or  dealer  who  was 
buying  goods,  not  for  consumption,  but  to  be  used  in  a  way  to 
make  a  profit  from  them.  The  prices  which  the  latter  stands 
ready  to  pay  for  given  quantities  of  any  particular  commodity 
express  his  estimates  of  the  significance  or  importance  which 
said  quantities  of  that  commodity  have  for  him.  It  follows  that 
we  may  treat  the  demand  schedule  of  any  individual  for  any 
particular  commodity  as,  in  effect,  the  significance  or  importance 
schedule  of  that  same  commodity.  Further,  supposing  the  com- 
modity in  question  to  be  divisible  like  the  apples,  whenever  the 
buyer  decides  to  take  a  particular  quantity  of  said  commodity, 
then  the  significance  or  importance  attaching  in  his  mind  to  the 
increment  of  demand  which  came  with  that  particular  price  is 
//it?  marginal  significance  of  that  amount  of  the  commodity;  the 
significance  of  the  next  portion  which  he  might  buy  would  be 
tlie  first  extra-marginal  significance  of  said  commodity;  while 
the  significance  of  the  portion  bought  next  before  the  last  would 
be  the  first  infra-marginal  significance  of  the  commodity. 

We  have  just  seen  that  demand  prices  in  the  individual  de- 
mand  schedule  are   expressions   of  the  significance  of  the  com- 
modity in  question  to  the  buyer.     We  must  now  add  that  the  \ 
ultimate  ground  of  significance  or  importance  to  the  individual  I 
is  utility,  capacity  to  satisfy  wants.     This  is  plain  enough  in  the  I 
case  of  the  demand  schedule  of  the  ultimate  consumer,  for  ex- 
ample, our  householder.     It  is  not,  however,  obviously  true  for 
buyers    who    are    offering    to    purchase    goods    intending    to    sell 
them  for  a  profit  or  to  use  them  in  producing  something  which 
they  will   sell.     The   ultimate  utilities   of   such   goods   or   their 
products  do  not  interest  the  buyers  now  under  consideration.    At 
bottom,    however,   the    cases    are   not   materially   different.     The 
demand  schedules  of  middlemen  and  producers  are  fairly  faith- 
ful embodiments  of  the  schedules  of  consumers.     When  they  are  . 
not.  dealers  or  producers  are  wont  to  go  into  bankruptcy.    Broad-  \ 
ly  speaking,  then,  it  remains  true  that  the  thing  which  in  the  last  I 
analysis    determines    demand    schedules    or    demand    prices    is  I 

235 


PRINCIPLES  OF  ECONOMICS 

I  utility  to  consumers.  Accordingly,  it  cannot  be  doubted  that  the 
iitilities  of  things  play  a  very  vital  role  in  determining  the  signifi- 
cances or  importances  of  which,  as  we  saw  above,  the  demand 
prices  of  the  individual  demand  schedule  are  expressions.  It 
follows  that  some  knowledge  of  the  nature  of  utility  and  the 
principles  governing  it  is  essential  to  an  adequate  comprehension 
of  individual  demand  schedules,  and,  hence,  of  the  general  de- 
mand schedule  with  which  the  market  deals.  It  becomes  neces- 
sary, therefore,  to  turn  aside  to  consider  briefly  the  most  import- 
ant points  in  the  theory  of  utility,  or  the  theory  of  wants  and 
their  satisfaction.  This,  however,  will  delay  us  but  a  moment, 
as  the  principles  needed  for  our  purposes  are  thoroughly  famil- 
iar and  obvious. 

Let  us  suppose  ourselves  to  take  some  divisible  commodity — 
a  commodity  which  we  can  buy  and  use  in  relatively  small  units 
— e.g.,  food,  and  make  a  series  of  experiments  with  respect  to 
the  degree  of  gratification  derivable  from  different  units  of  said 
commodity,  starting  with  zero  and  increasing  the  anjount  con^- 
sumed  by  small  increments.  In  the  course  of  such  an  experiment, 
we  should  doubtless  find  our  experience  breaking  into  something 
like  the  following  stages :  ( I )  gratification  increasing  more  than 
proportionately  to  the  amount  consumed,  (2)  gratification  in- 
creasing, but  less  than  proportionately,  (3)  gratification  not  in- 
creasing at  all,  (4)  gratification  changing  to  discomfort.  But,  of 
these  four  stages  the  last,  surely,  may  be  dismissed  at  once;  for 
no  one  would  enter  it  intentionally.  All  of  the  remaining  three 
perhaps  ought  to  be  retained ;  though  only  one  of  them  is  of 
considerable  importance.  With  most  of  us  there  will  be  only  a 
few  commodities  which  we  can  possess  in  sufficient  abundance  to 
carry  our  consumption  of  them  to  the  point  of  satiety,  the  point 
where  they  bring  us  no  further  gratification.  Again,  there  will 
be  only  a  few  very  expensive  luxuries  which  we  get  in  such  small 
amounts  that  an  increase  in  the  quantity  of  our  possessions  would 
/more  than  proportionately  increase  our  gratification.  In  short, 
|  with  respect  to  the  vast  majority  of  goods,  our  purchases  and 
stock  will  be  such  that  additions  would  increase  our  gratification 
I  but  not  proportionately  to  the  increase  in  quantity.  If  now  we 
put  these  points  into  formal  shape,  employing  the  word  utility 
to  express  the  power  of  goods  to  give  us  gratification,  we  shall 
have  the  following: 

Principle.     As  regards  its  capacity   to   give   to   the  consumer 

236 


CHAPTER  IX.     NORMAL   PRICE 

increase  of  gratification  with  increase  of  quantity,  any  divisible 
commodity  may  be  in  any  one  of  three  stages:  (i)  utility  in- 
creasing more  than  proportionately,  (2)  utility  increasing  less 
than  proportionately,  and  (3)  maximum  utility;  but,  in  practice, 
most  commodities  will  be  in  the  second  of  these  stages,  that  is, 
the  stage  of  utility  increasing  though  less  than  proportionately. 

To  bring  this  statement  of  the  case  into  closer  accord  with  the 
conventional  treatment  of  our  subject,  we  may  ignore  the  less 
important  stages  referred  to  and  lay  down  what  is  commonly 
known  as  the  law  of  diminishing  utility. 

Principle.     The  Law  of  Diminishing  Marginal  Utility. 

Broadly  speaking,  any  addition  to  our  stock  of  any  commodity 
will  make  some  addition  to  the  total  utility  enjoyed,  but  not  one 
proportional  to  the  quantity  of  the  commodity  added. 

We  have  just  seen  that,  as  respects  their  utility  or  power  to 
give  us  gratification,  commodities  are  subject  to  the  law  of  dimin- 
ishing marginal  utility.  But,  since,  as  was  explained  on  page  235, 
the  significance  or  importance  of  a  commodity  for  the  individual 
is  determined  by  its  utility,  it  quite  obviously  follows  that  a  prin- 
ciple similar  to  the  one  just  laid  down  will  apply  to  the  signi- 
finance*  or  importance  of  commodities. 

Principle.  Broadly  speaking,  the  total  significance  or  import- 
ance of  a.  stock  of  any  commodity  will  increase  with  its  amount 
but  not  proportionately;  so  that  the  marginal  significance  of  any 
commodity  varies  inversely  as  the  quantity  of  said  commodity  is 
available. 

We  seem  now  to  have  gone  quite  a  distance  from  our  starting 
point,  the  demand  schedule  of  the  individual.  The  student, 
however,  will  'have  little  difficulty  connecting  the  latest  results  of 
our  analysis  with  our  original  topic.  The  principles  just  brought 
out,  namely,  the  principle  of  diminishing  utility  and  the  consequent 
principle  of  diminishing  significance,  explain  the  most  important 
feature  of  our  demand  schedule,  that  is,  the  fact  that  it  is  a 
schedule  wherein  demand  varies  inversely  as  price.  For  these 
principles  say  in  effect  (i)  that,  by  adding  to  our  total  stock  of 
a  given  commodity,  we  can  increase  our  total  of  utilities  or  sig- 


*  It  is  quite  common,  in  setting  forth  the  laws  of  price,  to  employ  in 
this  connection  the  concept  of  utility.  But  for  various  reasons  we  shall, 
in  this  edition  of  our  text,  make  use  of  the  concept  "significance"  in 
preference. 

237 


PRINCIPLES  OF  ECONOMICS 

nificances  to  some  extent  anyhow,  and  (2)  that,  by  the  conduct 
indicated,  we  can  not  increase  said  utilities  or  significances  in 
proportion  to  the  increase  of  our  stock.  Now,  the  first  of  these 
two  facts — that  an  addition  to  stock  will  increase  utilities  or 
significances  to  some  extent  anyihow — is  necessary  to  explain 
why  we  are  willing  to  increase  our  purchases  if  the  right  price 
appears ;  for,  obviously,  if  additions  to  stock  give  no  increase 
in  utilities,  we  surely  would  not  buy  any  more,  whatever  the  price. 
On  the  other  hand,  the  second  fact — that  additions  to  our  stock 
will  not  increase  our  utilities  or  significances  in  proportion  to 
these  additions  to  stock — is  necessary  to  explain  why  our  buying 
more  is  conditioned  on  the  appearance  of  a  lower  price;  for, 
if  the  utilities  or  significances  of  the  new  increment  of  stocks 
were  as  great  as  the  old,  we  should  be  disposed  to  buy  more, 
even  if  price  did  not  fall. 

Note :  It  perhaps  ought  to  be  remarked  in  this  connection 
that  there  are  very  considerable  differences  among  the  demand 
schedules  of  the  individual.  Thus,  some  schedules  show  much 
more  elasticity  than  others, — that  is,  show  much  more  variation 
in  demand  with  variation  in  price.  For  example,  the  schedules 
of  necessaries  of  life  are  naturally  inelastic;  those  of  luxuries 
are  naturally  elastic.  Again,  some  schedules  are  commonly  much 
shorter  than  others ;  because  some  wants  are  much  more  quickly 
provided  for  to  the  point  of  satiation  than  are  other  wants.  Thus, 
the  schedules  of  goods  which  are  devoted  to  the  satisfaction  of 
physical  wants,  e.  g.,  food,  are  shorter  than  those  ministering 
to  higher  wants,  e.  g.,  books.  Utilities  of  the  former  decline  very 
rapidly ;  those  of  the  latter  very  slowly. 

Thus  far,  in  studying  utility,  we  have  been  concerned  with  the 
case  of  indefinitely  divisible  goods,  goods  the  unit  of  which  can 
be  made  indefinitely  small.  But  it  scarcely  need  be  said  that  not 
a  few  of  the  commodities  which  we  buy,  especially  if  our  incomes 
are  of  the  moderate  class,  are  indivisible  or  large-unit  goods. 
Thus,  each  one  of  us  'has  to  have  a  house,  a  furnace,  a  kitchen 
range,  a  dining-table,  etc.,  etc. ;  but  we  cannot  buy  today  10  cents 
worth  of  one  of  these  things,  tomorrow  another  10  cents  worth, 
the  next  day  another  10  cents  worth,  and  so  on;  that  is,  we 
cannot  rate  and  buy  separately  the  different  utilities  of  a  commod- 
ity of  this  'sort.  Instead,  we  must  estimate  and  purchase  all 
these  utilities  in  a  lump.  It  follows  that,  in  cases  of  this  sort, 
we  necessarily  buy  a  large  number  of  the  utilities  involved;  and, 
therefore,  it  is  inevitable  that  such  goods  should  for  us  have 

238 


CHAPTER  TX.     NORMAL   PRICE 

passed  beyond  Stage  i  and  well  into  Stage  2  ;*  that  is,  we  shall 
necessarily  come  into  possession  of  many  of  the  lesser  utilities 
derivable  from  these  goods  in  getting  any  of  them;  and,  there- 
fore, an  additional  unit  could  not  give  us  as  large  a  utility  as 
the  first  had  given  us.  It  follows  from  what  'has  just  been  said 
that  indivisible  goods  can  properly  be  brought,  in  a  general  way, 
under  the  principle  of  diminishing  utility  above  laid  down.  How- 
ever, one  or  two  comments  might  perhaps  well  be  added  While 
it  will  probably  always  be  true,  with  most  consumers,  that  the 
utilities  of  additions  to  stock  in  the  case  of  indivisible  goods  will 
be  diminishing  utilities;  it  will  not  always  be  true  that  these 
additions  to  stock  will  confer  any  utility  at  all; — i.  e.,  in  some 
cases,  additions  to  stock  will  bring  no  advantages  or  even  pos- 
itive disadvantages.  Again,  we  may  be  quite  sure  that,  in  any  case, 
the  individual  schedule  for  goods  of  this  sort  will  be  a  very 
brief  schedule, — with  rising  price,  the  complete  disappearance 
of  demand  will  come  very  quickly. 

We  have  now  carried  as  far  as  seems  needful  that  study 
of  the  individual  demand  schedule  which  was  undertaken  as  a 
condition  of  comprehending  the  composite  or  general  demand 
schedule  which  is,  of  course,  the  one  that  plays  the  decisive 
role  in  price-determination.  We  now  return  to  apply  the  material 
gained  to  these  composite  or  general  schedules.  First,  it  is 
to  be  affirmed  that  the  principles  governing  utility  insure  that  the 
general  demand  schedule,  like  the  individual  demand  schedule, 
will  be  subject  to  the  principle  that  demand  varies  inversely  as 
price.  Since  practically  all  individual  schedules  ,are  governed  by 
this  principle,  and  the  general  schedule  is  merely  the  summation 
of  these  individual  schedules;  any  other  result  would  be  possible 
only  in  quite  exceptional  cases. 

In  the  second  place,  it  follows  from  our  analysis  of  the  indi- 
vidual demand  schedule,  that  the  demand  prices  of  the  general 
schedule  are  money  expressions  of  the  marginal  significances 
of  the  several  amounts  of  goods  named  in  the  schedule, — as 
these  significances  are  estimated  by  the  particular  person  inter- 
ested. It  follows,  then,  that,  in  so  far  as  any  particular  demand 
price  constitutes  the  deeper  factor  or  one  of  the  deeper  factors 
determining  price  in  any  particular  case,  it  is  really  some 
particular  significance  of  the  commodity  in  question  which 
is  doing  the  work.  Accordingly,  in  any  formula  of 

*  In    some   cases,    anyhow,    they   will   have   reached    Stage   3. 

239 


PRINCIPLES  OF  ECONOMICS 

price-determination  which  contains  the  phrase  "marginal  demand 
price,"  we  can  properly  substitute  the  phrase  "marginal  sig- 
nificance,"— it  being  understood  that  the  significance  alluded 
to  is  measured,  not  by  some  common  mind  according 
to  a  common  standard,  but  by  the  individual  person  immediately 
interested. 

Note  (i)  In  the  above  explanation,  emphasis  was  laid  on  the 
point  that  the  demand  prices  of  the  general  schedule  are  expres- 
sions of  the  marginal  significance  of  the  corresponding  quantities 
of  the  commodity,  as  these  are  estimated,  not  by  some  common 
objective  mind,  but  by  the  particular  person  interested.  Now,  if 
we  were  dealing  with  the  schedules  of  some  individual,  and  noted 
two  significances  or  utilities  both  of  which  were  estimated  at  $i, 
we  s'hould  feel  justified  in  assuming  that  the  volume  of  these 
significances  or  utilities  were  substantially  equal.  On  the  other 
hand,  if  in  the  schedules  of  this  same  individual  we  met  two 
significances  the  estimates  of  which  were  respectively  $2  and  $i, 
we  should  feel  justified  in  assuming  that  the  former  of  these 
was  twice  as  great  as  the  latter.  Now,  even  in  the  case 
of  the  individual,  the  definiteness  involved  in  such  a  method  of 
speech,  is,  to  say  the  feast,  of  doubtful  propriety.  Taking  into 
account  the  variability  of  our  moods  and  the  inaccuracy  of  our 
self -judgments,  we  should  be  quite  unwarranted  in  treating  the 
figures  as  expressing  the  realities  of  the  case  with  any  great 
precision  or  nicety.  But,  whatever  may  be  true  in  the  case  of 
the  individual,  the  general  schedule  surely  cannot  be  treated  in 
this  way.  The  significances  there  expressed  in  money  prices  are 
surely  not  commensurable  as  absolute  magnitudes.  If  two  of 
them  are  expressed  by  the  same  figure,  $i,  it  by  no  means  follows 
that  they  are  equal  in  the  sight  of  an  absolute  intelligence.  If 
one,  of  them  is  expressed  by  $2  and  another  by  $i,  it  by  no 
means  'follows  that  the  absolute  magnitude  of  the  former  is 
twice  that  of  the  latter.  As  absolute  magnitudes,  significances 
which  are  represented  by  the  same  price  may  be,  quite  unequal ; 
while  significances  represented  by  different  prices  may  be  equal. 
This  would  be  true,  if  for  no  other  reason,  because  the  people 
demanding  goods  and  so  contributing  to  make  up  the  general 
demand  schedule  differ  greatly  in  respect  to  physical  and  moral 
health  and  so  in  respect  to  needs,  in  respect  to  sensibility,  in 
respect  to  capacity  to  feel  pleasure  or  pain  intensely,  and  so  on. 
But  more  important  than  these  is  the  fact  that,  because  men 
have  very  unequal  money  incomes,  the  same  nominal  measuring 
unit,  $1  or  whatever  it  may  be,  has  very  different  real  magni- 
tudes. A  want  on  which  the  poor  man  puts  an  estimate  of  5  cents 
may  be,  absolutely  considered,  as  great  as  one  on  which  the  rich 
man  puts  a  money  estimate  of  $i.  It  is  thus  plain, ^  that,  if  we 
are  to  conceive  the  prices  of  the  demand  schedule  as  in  any  sense 
expressing  significances  or  utilities,  this  must  be  with  the 
distinct  understanding  pointed  out  that  they  are  expressions  of 

240 


CHAPTER  IX.     NORMAL   PRICE 

said  significances  as  these  are  estimated  by  the  particular  person 
interested. 

(2)  It  will  perhaps  occur  to  the  student  that,  if  the  signifi- 
cances expressed  by  demand  prices  are  so  entirely  lacking  in 
homogeneity,  it  will  hardly  pay  to  use  these  concepts  at  all  in 
connection  with  general  demand  schedules,  however  useful  they 
may  be  in  connection  with  individual  demand  schedules.  In  fact, 
not  a  few  economists  'have  in  recent  years  taken  this  position.  In 
the  present  course,  however,  we  shall  act  upon  the  contrary  opin- 
ion;— that  is,  we  shall  set  forth  the  influence  upon  normal  price 
of  significances  or  utilities  as  represented  in  our  composite  demand 
schedules,  as  if  these  significances  were  factors  of  real  impor- 
tance in  the  determination  of  prices.  The  defence  of  this  position 
however  will  be  postponed  to  a  later  connection.  Here  we  shall 
work  out  the  merely  formal  relation  involved,  assuming  that  the 
results  can  be  shown  to  be  useful  at  a  later  time. 

I  will  now  close  this  long  discussion  of  normal  demand  sched- 
ules with  a  statement  in  respect  to  the  general  character  of  such 
schedules,  which  is  of  much  practical  importance.  It  is  this. 
Broadly  speaking,  substantially  all  general  demand  schedules  are 
of  the  kind  which  in  the  last  chapter  were  characterised  as  typ- 
ical,— that  is,  over  a  wide  range  of  prices,  these  schedules  show 
fairly  uniform  changes  in  demand  with  substantially  every  ma- 
terial change  in  price.  In  other  words,  these  schedules  are  high- 
ly regular  and  symmetrical.  Doubtless  this  must  be  affirmed 
less  roundly  of  some  than  of  others.  A  few  are  relatively  inelas- 
tic, e.  g.,  those  of  the  prime  necessaries  of  life;  but  even  these 
are  by  no  means  absolutely  unresponsive  to  the  influence  of 
price  changes.  This  fact  about  general  demand  schedules  is 
an  inevitable  result  of  the  conditions  involved.  (i)  Such 
schedules  are  composites  made  up  of  numberless  individual 
schedules.  (2)  The  tastes  and  wants  of  individuals  differ 
greatly.  (3)  'Most  of  all,  the  incomes  of  individuals  are 
very  unequal.  As  a  result  of  these  conditions,  there  will  be 
some  effective  demand  at  almost  every  price  level.  Even 
at  very  high  levels,  those  who  are  rich  and  wish  the  commodity 
in  question  intensely  will  continue  to  demand  it;  while,  with 
each  fall  in  price,  some  persons  who  care  less  or  have  smaller 
incomes  or  who  fulfil  both  conditions  will  come  in  with  a  new 
demand.  The  general  schedule  as  whole,  therefore,  will  show  a 
high  degree  of  continuity,  regularity,  and  symmetry. 

241 


PRINCIPLES  OF  ECONOMICS 

Section  D.  Normal  Price  of  Fixed-Supply  Goods. 
We  have  now  the  data  necessary  to  enable  us  to  bring  out 
the  deeper  principles  regulating  the  long-time  or  normal  prices 
of  things.  Let  us  begin  with  the  general  case  of  fixed-supply 
goods.  As  an  example,  we  will  take  copies  of  the  Basel  edition  of 
Sir  Thomas  More's  Utopia.  Let  us  suppose  that,  at  about  the  same 
time  in  the  year  1913,  three  or  four  different  finds  are  made 
bringing  on  the  market  a  new  supply  of  these  books  amounting 
to  ten  copies.  Let  us  suppose,  further,  that  the  demands  of  li- 
braries and  private  collectors  are  such  that  the  aggregate  demand 
schedule  is  as  follows:  I  copy  wanted,  if  price  is  $200;  2  copies, 
if  price  is  $175;  4  copies,  if  $160;  6  copies,  if  $125;  10  if  $100; 

n,  if  $90;  14,  if  75;  and  so 
Demand  Price  Supply    on.    Under  these  conditions, 

what  must  the  price  tend  to 
oo  02.  dollars  ooo  oz.         be,  and"  what  principles  will 

1  200  10          regulate    that    price?      The 

2  175  10          hypothesis  as  stated  is  rep- 
4                     150  10          resented  in  the  accompany- 
6                   125                   10          ing     demand     and     supply 

10  100  10          schedule.     A  glance   shows 

11  90  10  that    the    price    could    not 
14  75  10  be     above     $100;     for,     if 
16  60  10  it  went  above  this  figure,  4 
20  50  10  buyers  would  then  withdraw 

making     demand     deficient, 

and,  in  order  to  guard  against  this  result,  the  sellers  would  bring 
price  down  to  $100.  On  the  other  hand,  price  could  not  go  down 
to  $00;  since,  if  it  did,  two  new  buyers  would  come  in,  making 
demand  excessive,  a  result  which  $ioo-buyers  would  have  to 
guard  against  by  bidding  price  up  to  at  least  $91. 

Let  us  now  analyze  this  result  in  detail.  In  the  first 
place,  we  see  that  our  old  law  of  supply  and  demand  is  operative, 
— that  is,  a  price  must  be  reached  at  which  demand  and  supply 
are  equal.  In  this  case,  however,  we  are  able  to  affirm  the  law 
in  a  somewhat  special  sense.  For,  since  supply  is  constant  and 
so  demand  only  can  change,  the  proposition  that  we  must  have 
a  price  at  which  demand  and  supply  are  equal  is  really  best  stated 
in  the  following  form. 

Principle.  In  the  case  of  fixed-supply  goods,  the  normal  price 
242 


CHAPTER  IX.     NORMAL   PRICE 

must  tend  to  be  that  price  or  some  one  of  that  series  of  prices 
which  will  cause  demand  to  become  equal  with  the  unchanging 
supply.  Or,  more  briefly,  the  normal  price  must  tend  to  be  that 
one  or  some  one  of  that  series  which  will  equate  demand  to 
stock. 

Note :  As  explained  earlier,  in  cases  like  that  before  us,  if 
demand  and  stock  are  not  quite  equal  at  one  of  the  prices  given 
in  the  schedule,  the  necessary  equating  of  demand  to  stock  would 
usually  be  effected  in  practice  by  compromise  prices  between 
those  given  in  the  schedule.  That  is,  there  would  be  equality  of 
demand  and  supply  reached  at  $95  or  $94  or  $97  and  so  on.  If 
in  any  particular  case  this  should  not  result,  there  would  be  no 
price  which  had  complete  stability, — actual  price  would  tend  to 
oscillate  between  the  lowest  one  at  which  supply  exceeded  demand 
and  the  highest  one  at  which  demand  exceeded  supply. 

A  second  proposition  which  is  plainly  applicable  to  the  case 
before  us  is  contained  in  the  following: 

Principle.  In  the  case  of  fixed-supply  goods,  the  normal  price 
must  be  one  of  the  prices  ranging  from  a  limit  fixed  by  the  mar- 
ginal demand  price,  and  that  only,  down  to  a  limit  fixed  by  tJie 
first  extra-marginal  demand  price,  and  that  only. 

The  argument  is  plain.  As  we  saw  in  our  first  analysis  of  this 
case  of  the  copies  of  Utopia,  at  least  one  reason  why  normal 
price  could  not  be  above  $100  is  that,  unless  price  is  as  low  as 
$100,  the  last  increment  of  demand,  4  copies,  will  not  appear  ,at 
all  and  hence  sellers  will  be  obliged  to  bid  actual  price  down  to 
$100  to  insure  disposal  of  the  stock.  That  is,  that  one  of  the 
variables  fixing  the  upper-limit  of  price  which  comes  from  de- 
mand, the  marginal  demand  price,  is  actually  operative  in  the 
case  before  us.  But,  again,  it  is  plain  that  this  is  the  only  one 
of  the  two  motives  which  may  compel  sellers  thus  to  bid  price 
down  which  is  here  operative.  The  other  consideration,  that, 
if  they  do  not  thus  bid  price  down,  a  new  supply  will  be  forth- 
coming is  not  operative ;  since  there  is  no  new  supply  to  come  in, 
— supply  is  constant.  In  other  words,  in  the  case  before  us,  the 
first  extra-marginal  supply  price  has  no  share  in  fixing  the  upper 
limit  of  actual  price.  That  limit  is  fixed  by  the  marginal  demand 
price  only. 

Turning  now,  to  the  lower  limit  of  price  in  this  case, 
it  is  evident  that  actual  price  could  not  go  down  to  $90  because 
this  would  make  demand  increase  by  one  copy,  thus  compelling. 

243 


PRINCIPLES  OF  ECONOMICS 

buyers  to  bid  price  up  to  some  figure  above  this  point  in  order 
to  exclude  this  increment  of  demand.  That  is,  the  demand  price 
lower  limit,  $90,  the  first  extra-marginal  demand  price,  is  actually 
operative.  That  is,  buyers  do  not  have  to  keep  price  up  in  order 
to  keep  in  the  marginal  supply;  since  by  hypothesis  supply  is 
constant  and  therefore  will  not  fall  off  with  a  declining  price. 

The  principle  last  set  forth  has  brought  out  the  point  that  the 
determination  of  normal  price  in  the  case  before  us  is  entirely  in 
the  hands  of  demand  price.  But  in  Section  C  it  was  'made 
clear  that  demand  prices,  when  more  deeply  considered,  are 
money  expressions  of  the  significance  which  goods  possess  for 
buyers  as  this  significance  is  estimated  by  those  buyers  themselves. 
It  follows  that  in  the  principle  just  laid  down  we  can  substitute 
"significance"  for  "demand  price*'  in  every  case.  The  principle 
thus  amended  would  read  as  follows : 

Principle.  In  the  case  of  fixed-supply  goods,  the  normal  price 
-must  be  one  of  the  series  of  prices  which  is  limited  above  by 
that  price  which  expresses  the  marginal  significance  of  the  com- 
modity in  question  and  is  limited  below  by  that  price  which 
expresses  the  first  extra-marginal  significance  of  said  commod- 
ity. The  prices  of  such  goods  of  this  class  as  are  producible  are 
not  influenced  by  their  cost  of  production. 

Note :  One  phase  of  this  principle  is  of  great  practical  im- 
portance. I  mean  the  fact  that  there  is  a  downward  limit  to  nor- 
mal price  in  the  first  extra-marginal  significance  of  the  commod- 
ity involved.  In  the  case  of  one  particular  commodity  of  this 
sort,  namely  labor,  this  point  is  overlooked  by  a  very  large  num- 
ber of  the  general  public  and  also  occasionally  even  by  econo- 
mists. That  is,  such  persons  frequently  have  the  impression  that 
there  is  no  downward  limit  to  the  wages  which  the  laborer  will 
have  to  take  except  his  own  determination  to  refuse  the  lower 
figure.  But,  obviously,  the  competition  of  employers  who  wish 
to  put  labor  to  the  first  extra-marginal  use  constitutes  a  reason 
why  the  price  of  labor  should  not  fall  indefinitely.  Now,  if  the  first 
extra-marginal  use  is  but  little  below  the  marginal  one,  and 
this  is  quite  likely  to  be  the  case,  it  is  to  be  expected  that  the 
competition  of  employers  would  keep  wages  from  falling  mate- 
rially below  the  marginal  significance  of  the  labor  furnished. 
This  of  course  assumes  perfect  freedom  of  competition,  complete 
knowledge  on  the  part  of  employers  as  to  what  laborers  are 
worth  to  them,  and  complete  freedom  of  movement  to  laborers 
so  that  they  can  improve  any  opportunity  that  employers  would 
naturally  give  them.  Doubtless  such  perfection  of  competition, 
such  completeness  of  knowledge  on  the  part  of  employers 

244 


CHAPTER  IX.     NORMAL   PRICE 

and  of  mobility  on  the  part  of  labor,  is  seldom  rea- 
lized; but,  for  our  present  purposes,  we  are  dealing  with  what 
would  be  expected  under  the  hypothetical  conditions  which  our 
science,  like  every  other  science,  assumes  when  attempting  to 
ascertain  the  fundamental  principles  which  govern  the  phenomena 
it  has  to  investigate. 

Our  principle,  as  laid  down  above,  defines  the  limits  of  price- 
variation,  rather  than  definitely  fixing  said  price.  This  cautious 
procedure,  though  necessary  from  the  theoretic  standpoint,  is 
hardly  necessary  in  practice,  for  the  reason  that,  in  most  cases 
significance  or  utility  schedules  are  substantially  continuous, 
unbroken — every  change  in  the  price  of  the  commodity  is  match- 
ed by  a  normal  change  in  its  marginal  significance.  In  con- 
sequence of  this,  the  marginal  significance  and  the  first 
extra-marginal  significance  will  commonly  be  in  juxta- 
position ;  and,  hence,  it  is  only  necessary,  in  most  cases,  to 
affirm  that  price  must  express  marginal  significance.  Amending 
the  statement  of  our  principle  in  accord  with  this  view  of  the 
matter,  we  have  the  following : 

Principle.  Generally  speaking,  the  normal  price  of  a  fixed- 
supply  commodity  must  tend  to  be  that  price  which  expresses 
the  marginal  significance  or  utility  of  the  existing  stock  of  said 
commodity. 

ILLUSTRATIVE  PROBLEMS. 

1.  During  the  current  year,  there  came  on  the  market  from 
various  sources  twelve  specimens  of  a  certain  rare  object.     If 
the  ultimate  demand  schedule  proves  to  be  as  follows :  1  wanted 
at  $60;  2  more  at  $55;  4  more  at  $50;  5  more  at  $45;  6  more  at 
$40;  etc.,  what  price  will  in  the  long  run  tend  to  be  reached? 
Prove. 

2.  In  a  certain  year  the  output  of  wheat  proved  to  be  2,000 
millions  of  bushels.    The  ultimate  demand  schedule  for  the  year 
ensuing  till   the  next  harvest  was  as    follows:     1,600  mil.   bu. 
wanted  if  price  were  $1.30;  1,800  mil.  if  price  were  $1.25;  2,000 
mil.  if  $1.20;  2,200  mil.  if  $1.15;  and  so  on. 

(a)  What  price  would  tend  to  prevail  for  that  year?    Prove 
in  detail. 

(b)  What  would  determine  it? 

(c)  What  price  would  tend  to  prevail,  if  the  demand  moved 
up  a  step,  making  the  schedule  1,800  mil.  at  $1.30;  2,000  mil.  at 
$1.25;  2,200  at  $1.20;  2,400  at  $1.15;  and  so  on? 

(d)  What  price  if  demand  moved  up  two  steps,  making  the 
schedule:  2,000  mil.  at  $1.30;  2,2'00  at  $1.25;  and  so  on? 

(e)  What  price  if  demand  moved  down  two  steps,  making 

245 


PRINCIPLES  OF  ECONOMICS 

the  schedule:  1,200  mil.  wanted  at  $1.30;  1,400  mil.  at  $1.25;  1,600 
at  $.20;  1,800  at  $1.15;  2,000  at  $1.10;  and  so  on. 

3.  Suppose  we  were  dealing  with  a  longer  period  than  one 
year  and  the  average  annual  supply  schedule  was  of  the  variable 
kind,  running  as  follows:  2,400  mil.  bu.  furnished  if  price  were 
$1.30;  2,200  mil.  if  $1.25;  2,000  mil.  if  $1.20;  1,800  mil.  if  $1.15; 
and  so  on. 

(a)  Supposing  the  average  annual  demand  schedule  to  be  the 
first  one  given  under  Problem  2,  what  would  the  long-run  price 
tend  to  be?     Prove. 

(b)  Supposing  the  demand  schedule  to  be  as  in  Pr.  2   (d), 
what  price  would  tend  to  prevail? 

(c)  Compare  this  result  with  that  reached  in  Pr.  2  (d),  and 
point   out   the   difference   in   the  processes    whereby   prices    are 
determined  in  the  two  cases. 

4.  "In  1348-49  the  black  death  carried  off  from  one-third  to 
one-half  of  England's  workingmen.  In  consequence  wages  greatly 
advanced." 

(a)  Explain  the  advance  in  wages  on  the  basis  of  the  Law 
of  Supply  and  Demand  given  on  page  199,  constructing  for  the 
purpose  imaginary  demand'  and  supply  schedules. 

(b)  Explain  the  advance  in  wages  on  the  basis  of  Marginal 
Significance  principle  given  above. 

(c)  Discuss  this  statement :     "Wages  rose  because  the   de- 
mand for  the  laborers  who  were  left  had  greatly  increased." 

5.  Suppose  that  the  s.upply  and   demand   schedules   for  the 
rare  brand  of  tea  which  you  get  from  page  227,  are  identical  with 
the  ultimate  schedules. 

(a)  What  must  the  normal  price  of  this  brand  of  tea  tend 
to  be  under  Demand  Schedule  D?     Prove. 

(b)  What  would  it  be  if  the  supply  schedule  were  changed  so 
as  to  read:  4,000  pounds  if  price  is  50  cents;  6,000  if  75  cents; 
and  so  on  up  to  11,600  if  price  is  $5,  after  -which  no  increase  in 
supply  takes  place. 

(c)  This    last    example    shows    that    a    particular    element 
which  often  shares  in  the  fixing  of  price,  in  this  tea  case  plays 
no  part,  leaving  the  work  to  be  done  by  marginal  utility.     What 
is  the  excluded  element? 

Section  E.  Normal  Price  of  Constant-Cost  Goods. 
In  the  section  just  preceding,  we  discussed  what  were  called 
fixed-supply  goods,  meaning  goods  the  ultimate  supply  of  which 
for  its  normal  price  period  is  substantially  determinate — can  not, 
economically  speaking,  change.  These  goods  are  strictly  non- 
producible,  or  non-producible  during  the  normal  price  period,  or 
producible  only  under  such  conditions  that,  unless  a  quite  ab- 
normal change  in  demand  should  take  place,  their  output  is  sub- 

246 


CHAPTER  IX.     NORMAL   PRICE 

stantially  fixed.  We  must  now  consider  that  large  class  of  goods 
which  are  producible  under  such  conditions  that,  within  any 
range  which  demand  is  at  all  likely  to  traverse,  their  output  is 
capable  of  almost  indefinite  contraction  or  expansion,  and  the 
supply  offered  can  and  will  materially  change  with  changing  price. 
Goods  of  this  class  we  have  already  subdivided  into  constant-cost 
and  increasing-cost  goods.  We  will  begin  with  the  sub-class, 
constant-cost  goods. 

The  theory  of  this  case  is  comparatively  easy  to  dispose  of 
after  the  preparation  derived  from  preceding  discussions.  First, 
let  us  remind  ourselves  that  constant-cost  goods  have  single-price 
supply  schedules,  i.  e.,  supply  schedules  in  which  there  is  one 
price  at  which  a  substantially  indefinite  supply  is  forthcoming, 
while  below  that  price  practically  no  supply  is  to  be  had,  consid- 
ering the  volume  of  demand,  and  at  prices  above  said  price  no 
additions  to  supply  take  place.  It  follows,  therefore,  that  the 
principle  already  brought  out  (page  220)  for  goods  having  sin- 
gle-price supply  schedules  furnishes  us  with  one  principle  ap- 
plicable to  constant-cost  goods,  viz.,  the  principle  that  the  normal 
price  of  such  constant-cost  goods  must  tend  to  coincide  with  the 
one  supply  price. 

But,  again,  the  one  supply  price  of  goods  of  this  class  is  their 
cost  of  production.  It  follows,  therefore,  that,  in  our  formula 
for  this  case,  we  may  substitute  for  the  phrase  "single  supply 
price''  the  much  more  significant  phrase  "cost  of  production." 
Accordingly,  our  principle  for  this  case  is  the  following. 

Principle.  The  normal  price  of  constant-cost  goods,  the 
continued  production  of  which  is  demanded,  must  approximately 
equal  their  cost  to  representative  producers. 

As  an  example  illustrating  this  principle,  let  us  take  the 
wooden  chair,  the  ultimate  supply  schedule  of  which  was  discuss- 
ed on  page  229.  As  already  pointed  out,  this  is  a  constant-cost 
commodity  only  while  demand  ranges  between  500,000  and  2,000,- 
ooo ;  since  before  that  cost  is  diminishing  with  increased  output 
while  later  it  is  increasing.  Since  producers  will  of  course  stand 
ready  to  supply  at  prices  above  30  cents  as  many  chairs  as  they 
would  at  that  figure  while  below  30  cents  they  will  supply  none,  it 
is  possible  to  fill  out  a  many-price  supply  schedule  of  the  usual 
form ;  and  this  is  perhaps  desirable.  Let  us  now  make  such  a 
supply  schedule  and  combine  it  with  several  demand  schedules, 
as  a  result  of  which  we  have  the  following  table: 

247 


PRINCIPLES  OF  ECONOMICS 


SUPPLY.  .. 

.       PRICE 

DEMAND    000 

000 

Dollars 

Sch.A 

Sch.  B 

Sch.  C 

Sch.  D 

Sch.  E 

500-2000 

3 

2 

3 

3 

5 

5 

500-2000 

2 

10 

12 

15 

20 

20 

500-2000 

1 

50 

51 

60 

80 

80 

500-2000 

.75 

300 

500 

810 

1100 

IIOO 

500-2000 

.50 

500 

750 

1020 

1400 

1400 

500-2000 

.40 

600 

895 

1200 

1520 

1400 

500-2000 

.30 

700 

950 

1540 

1840 

1400 

0 

.25 

1000 

1210^ 

2000 

2560 

1400 

0 

.20 

1500 

1800 

2560 

2800 

1400 

4 

0 

.15 

2500 

3000 

3800 

4563 

1400 

If,  now,  we  combine  the  supply  schedule  of  this  table  with 
demand  schedule  A,  we  see  at  once  that  a  price  of  30  cents  must 
tend  to  prevail.  If  proof  is  needed,  it  is  found  along  the  lines 
already  followed.  The  price  can  not  be  higher  than  30  cents,  say 
40 ;  because  at  that  price  demand  will  be  less  than  supply  at  30 
cents,  and  sellers  at  the  last  figure  competing  to  get  the  market 
will  bring  price  down  to  that  point.  On  the  other  hand,  price 
can  not  be  below  30  cents,  say  25 ;  because  at  that  price  supply 
will  become  zero  and  so  vastly  less  than  demand  at  30  cents,  as 
a  consequence  of  which,  buyers  at  the  last  figure,  in  order  to  get 
their  wants  supplied,  will  raise  price  to  that  point.  Reasoning 
precisely  similar  to  that  just  used  'would  show  us  that  this  same 
price  of  30  cents  would  tend  to  prevail  if  the  demand  schedule 
were  B  or  C  or  D  rather  than  A.  In  fact,  whatever  the  demand 
schedule,  so  long  as  demand  at  30  cents  were  not  smaller  than 
500,000  and  not  larger  than  2,000,000,  actual  price  would  neces- 
sarily tend  to  be  just  30  cents. 

Note:  (i)  The  formula  for  these  goods  laid  down  above 
contains  the  qualifying  phrase  "the  continued  production  of  which 
is  demanded."  The  necessity  for  this  will  easily  be  seen.  As  ex- 
plained in  Section  B  of  this  chapter,  if  a  producible  'commodity 
is  no  longer  demanded  in  such  quantity  and  at  such  price  as  to 
warrant  its  further  production,  the  existing  stock  of  such  a  com- 
modity passes  into  the  class  of  fixed-supply  goods,  e.  g.,  hats  out 
of  style.  Commodities  of  this  sort  have  to  sell  for  whatever 
price  buyers  will  pay : — their  price  becomes  a  matter  of  their 
marginal  significance  solely.  Cost  determines  the  price  of  any 
commodity  only  when,  and  because,  it  is  in  a  position  to  influence 
potential  future  supply.  But,  if  no  future  supply  is  wanted,  a 
cause  which  can  influence  price  only  through  its  relation  to  future 
supply  can  have  no  part  whatever  in  fixing  price. 


248 


CHAPTER   IX.     NORMAL   PRICE 

(2)  The     point     made     in     the     preceding     comment     must 
not  be  understood  as  in  any  degree  a  relinquishing  of  the  main 
contention  of  our  principle,  viz.,  the  contention  that,  in  the  case 
before  us,  cost  determines  price.     So  long  as  the  conditions  sup- 
posed exist,  the  price  of  our  wooden  chair  will  tend  to  be  30 
cents;  and  this  will  be  true  because  the  cost  of  production  is  30 
cents,  and  for  that  reason  only.    But  perhaps  this  may  sems  to 
be  an   overstatement  of  the  case.     Under  each  of  the  different 
demand  schedules  used  above,  price  coincided  with  marginal  sig- 
nificance just  as  much  as  it  did  with  marginal  cost  of  production. 
Thus,  in  Schedule  A,  there  are  100,000  chairs  which  are  wanted 
only  provided  the  price  is  as  low  as  30  cents ;  in  Schedule  B  there 
are  55,000  such;  in  Sch.  C,  340,000;  and  in  Sch.  D,  320,000;  and 
the    significance    of    these    chairs,    the    marginal    significance   of 
chairs  in  general,  is  obviously  30  cents.     Price,  in  short,  coincides 
with  marginal  significance  just  as  much  as  with  marginal  cost. 
Can  it  not,  therefore,  be  plausibly  contended  that  marginal  sig- 
nificance plays  just  as  much  of  .a  'part  in  the  immediate  determina- 
tion of  normal  price  as  does  marginal  cost?    The  correct  answer 
is  undoubtedly  a  negative  one.     While  the  marginal  significance 
must  be  as  high  as  30  cents,   it  may  be  much  higher;   so  that, 
if  marginal  significance  really  coincides  with  an  actual  price  of 
30  cents,  as  it  does  under  Schedules  A,  B,  C,  and  D,  this  means, 
not   that   marginal  significance  has  fixed  price,  but   that  it  has 
adjusted  itself  to  a  price  fixed  by  cost. 

In  order  to  clear  up  this  point  beyond  question,  let  us  make 
a  slight  change  in  our  hypothesis.  First,  let  us  suppose  that  the 
actual  demand  schedule  is  the  one  labelled  E  in  our  table,— 
being  really  Schedule  D  so  altered  that,  after  price  reaches  a 
point  as  low  as  50  cents,  no  increase  in  demand  would  take 
place,  though  price  should  fall  to  40  cents  or  30  cents  or  any 
lower  figure.  Under  such  a  hypothesis,  whatever  the  price  should 
become,  the  marginal  significance  of  our  chairs  would  continue 
to  be  50  cents  each.  Again,  let  us  suppose  that  the  cost  of  pro- 
duction has  hitherto  been  50  cents;  and  that  the  actual  price  of 
50  cents  has,  therefore,  both  expressed  the  marginal  significance 
of  the  chairs  and  equalled  their  cost  of  production.  These  conr- 
ditions  being  given,  let  us  now  suppose  that  something  happens 
to  'bring  cost  of  production  down  to  30  cents,  while  no  change 
in  the  demand  schedule  takes  place.  Will  actual  price  now  fol- 
low the  new  cost,  30  cents,  or  stick  to  the  marginal  significance, 
50  cents?  The  answer  surely  is  that  it  will  follow  the  new  cost: 
the  competition  of  producers  would  permit  no  other  result.  But, 
this  being  true,  it  is  plain  that  the  coincidence  of  actual  price 
with  marginal  significance,  when  we  have  the  demand  schedules 
A  or  B  or  C  or  D,  is  not  necessary  to  the  determining  of  the 
actual  price  of  50  cents;  instead,  it  is  merely  an  incident,  being 
effected  by  the  adjustment  of  the  marginal  significance  to  a 
price  already  determined  by  cost  of  production. 

(3)  In  the   formula  embodying  our  principle,  the  word  cost 

249 


PRINCIPLES  OF  ECONOMICS 

is   qualified   by  the   phrase   "to   representative   producers.''     The 
purpose  of  this  qualification  is  to  shut  out  two  costs  either  of 
which  might  perhaps  be  suggested  to  the  student's  mind  if  the 
word  cost  were  used  alone.     These  are   (i)   the  very  low  cost 
of   a   few   specially   favored   producers   having   limited   capacity, 
and  (2)  the  very  high  cost  of  a  few  specially  inefficient  produc- 
ers who  will  anyhow  remain  in  the  business  till  death  or  bank- 
ruptcy   intervenes.     The    former,    being  unable    to    furnish    the 
whole  supply  required,  could  not,  if  they  would,  bid  price  down     / 
to  their  own  cost.     The  latter,  not  being  in  a  position  to  with-     / 
hold  their  addition  to  output  even  when  price  is  below  their  cost,    / 
cannot  pull  price  up  to  their  cost.     Neither  of  these,  therefore,   / 
furnishes  the  price-determining  cost.     That  cost  is  cost  to  nor- 
mat,  typical,  representative  producers. 

Caution :  In  the  preceding  analysis,  it  has  been  assumed 
that  the  money  prices  of  cost  goods  are  fixed  in  advance  of  their 
use  in  production  and  so,  setting  put  from  this  starting  point, 
cost  can  move  forward  to  fix  prices.  The  entrepreneur,  we 
have  implied,  finds  the  wages,  interest,  rent,  and  so  on  which  he 
must  pay,  determined  in  advance;  and  so  the  amount  of  his 
cost  comes  to  be  entirely  a  question  of  how  much  labor  service, 
capital  service,  land  service,  and  so  on  he  needs  to  produce  trie 
commodity.  If  such  an  assumption  were  really  true,  it  would 
anyhow  be  evident  that  we  have  not  yet  reached  the  end  of  our 
task, — that  the  ultimate  forces  determining  prices  are  not  yet 
disclosed;  for  we  should  still  need  to  find  out  how  the  prices 
of  the  ultimate  cost  goods  were  determined.  As  a  matter  of 
fact,  however,  it  surely  is  not  true  in  the  full  sense  that  the 
prices  of  the  ultimate  cost*  goods  are  determined  in  advance  of 
their  use  in  production.  Such  use  of  those  cost  goods  must 
surely  have  some  share  at  least  in  the  determining  of  their 
prices.  If  the  employer  finds  himself  getting  unexpectedly  high 
prices  for  the  products  which  labor  helps  him  to  put  out,  in 
some  cases  certainly  he  will  sooner  or  later  find  himself  obliged 
to  pay  a  higher  price  for  that  labor,  i.e.,  to  incur  a  higher  cost. 
In  a  word,  we  seem  to  be  involved  in  a  circle, — the  prices  paid 
for  cost  goods  determine  the  prices  of  product  goods,  where- 
upon the  prices  of  product  goods  react  to  determine  the  prices 
of  cost  goods. 

The  difficulties  suggested  by  the  preceding  paragraph  are 
real  and,  from  some  standpoints,  they  are  important.  Neverthe- 
less, the  principle  above  laid  down,  that  price  tends  to  equal 
cost,  is  universally  admitted  to  be  true  for  practical^  purposes 
and  by  most  economists  is  also  held  to  be  of  great  significance 
for  practical  purposes.  The  business  manager,  the  prospective 
investor,  the  prospective  buyer,  the  statesman  concerned  with  the 
levying  of  taxes,  and  so  on, — all  these  will  constantly  find  them- 
selves called  on  to  act  as  if,  for  their  purposes,  the  principle  we 
have  laid  down  were  the  last  word.  Thus,  if  the  manufacturers 
of  a  certain  commodity  are  able  to  put  it  on  the  market  in 
indefinitely  large  amounts  at  a  cost  of  $3,  they  would  be  very 

250 


CHAPTER  IX.     NORMAL  PRICE 

foolish  indeed  to  expect  the  price  to  remain  at  any  figure 
materially  above  $3,  even  though  for  many  months  it  had  been 
in  the  neighborhood  of  $5.  Again,  if,  when  a  certain  commodity 
is  being  put  on  the  market  by  representative  producers  at  a 
cost  of  50  cents  per  unit  and  is  selling  at  that  figure,  govern- 
ment levies  on  its  production  a  tax  of  $1.50  per  unit,  thus 
making  it  cost  substantially  $2.00,  its  price  will  almost  cer- 
tainly rise  to  approximately  that  figure.  In  a  later  connection, 
we  shall  try  to  clear  up  some  of  the  difficulties  suggested  above. 
But,  for  the  present,  it  is  our  business  to  impress  this  upon  the 
student  that,  however  much  the  principle  of  cost  falls  short 
of  furnishing  an  ultimate  explanation  of  values,  that  principle  is 
after  all  of  real  and  great  importance  in  the  actual  conduct  of 
economic  life. 

ILLUSTRATIVE  PROBLEMS. 

1.  Suppose  the  conditions  for  producing  Portland  cement  to 
be  such  that  any  quantity  from  5  millions  barrels  to  500  millions 
can  be  put  on  the  market  at  a  minimum  cost  of  about  $1.15  per 
barrel;  while  any  output  from  500  millions  to  800  would  cost 
$1.25  per  barrel. 

What  would  price  tend  to  be  under  each  of  the   following 
demand   schedules?     Marginal  utility? 

PRICE  DEMAND  000,000 

A  B  C  D  E  F 

3.00  1  30  5  15       .        5  20 

2.50  2  75  15  25  15  50 

2.25  5  100  25  44  35  70 

2.00  10  200  40  60  43  100 

1.75  11  400  60  100  75  200 

1.50  13  600  75  200  180  350 

1.25  15  700  75  300  200  450 

1.15  20  800  75  367  263  495 

1.10  25  1000  75  400  300  550 

1.05  30  1100  80  430  320  600 

1.00  50  1500  100  500  400  800 

2.  "Let  us  suppose  that   five  or  six  concerns  are   supplying 
the  building  brick  used  in  a  certain  district,  and  that  by  a  new 
method  of  manufacture  they  manage  to  double  their  output  for 
the    former  expenses   of  labor.     What  will  'happen   as   regards 
the  price  of  brick?     From  our  knowledge  of  what  competition 
usually  does,  we  are  apt  to  say:  the  price  of  brick  will  fall  50 
per  cent.     This  may  be  the  final  result,  but  not  necessarily  sor 
and   at    any   rate   the   movement   of   price   is    instructive.     The 
manufacturers   are  now   able  to  sell  at  half  the   price  if  they 
wish,   but  it  is  their  interest  to  keep  up  the  price  as  long  as 
they    can.      What,    however,    will    certainly    happen,    in    normal 
circumstances,    is    that    they   will    increase   their    production    of 
brick.     But  it  is  not  the  case  that,   whatever  nature  and  man 

551 


PRINCIPLES  OF  ECONOMICS 

produce,  men  will  desire;  it  is,  rather,  that  what  man  wants  he 
usually  sets  nature  and  man  to  produce.  To  take  off  the  extra 
supply  of  brick,  then,  the  manufacturers  must  find  a  wider 
circle  of  demand  than  before;  but  there  is  nothing  to  lead  us 
to  suppose  that  there  is  any  wider  circle  of  demand  at  the  old 
price.  What  we  may  safely  suppose  is  that  a  great  many  new 
people  will  buy  brick  for  building  purposes  if  they  can  get  them 
cheaper,  but,  in  any  case,  the  decision  lies  absolutely  with  them 
whether  they  will  take  more  or  not.  It  is  easy  to  fall  into  the 
mistake  of  thinking  that  there  will  be  a  demand  for  everything 
produced  if  it  is  sold  at  a  reasonable  price,  but  this  idea  simply 
arises  from  the  fact  that  producers  anticipate  desire  and  tempt 
demand.  In  the  present  case  demand  must  come  from  some 
level  of  want  which  was  not  satisfied  at  the  former  price,  and 
is  ready  waiting  to  take  up  the  extra  supply  if  the  price  is 
brought  down. 

"If,  however,  as  may  well  happen — not  in  the  case  of  brick 
probably,  but  in  large  articles  of  limited  consumption — there  is 
no  such  circle  of  demand  at  lower  levels,  what  will  happen  is 
that  the  manufacturers  will  cut  down  their  output  to  the  same 
quantity  of  brick  as  before,  and  maintain  the  former  high  price. 
For  brickmakers,  like  other  business  men,  do  not  put  themselves 
on  'salaries,'  and  give  the  public  the  benefit  of  all  cheapening  of 
production.  It  is  characteristic  of  the  capitalistic  employer  in 
all  departments  that  he  speculates  on  having  a  profit,  and  thinks 
no  profit  too  high,  just  because,  as  a  speculative  gain,  it  may  be 
balanced  any  year  by  as  great  a  loss.  It  is  contrary,  then,  to 
all  experience  to  think  that  employers  will  voluntarily  reduce 
prices — any  more  than  they  will  voluntarily  raise  wages  or  pay 
higher  interest — because  costs  have  decreased.  They  only  do 
so  under  compulsion  of  fear  that  their  rivals  will  cut  the  feet 
from  under  them.  Where  competition  is  active  it  will  often  seem 
as  though  reduction  of  costs  were  almost  immediately  followed 
by  fall  in  prices  of  products,  but,  in  the  last  resort, — and  that 
is  what  concerns  us  in  seeking  for  a  universal  law  of  value — 
the  new  prices  are  determined  by  the  lower  and  wider  levels  of 
want  which  are  ready  to  take  up  increased  supply  of  the  majority 
of  ordinary  commodities." 

The  above  quotation  is  taken  from  the  writings  of  an  able 
economist.  It  has  been  modified  at  a  few  points  to  eliminate 
ambiguities.  I  think,  however,  that  it  does  not  misrepresent  his 
views.  In  any  case,  it  brings  out  a  way  of  looking  at  the  mat- 
ter which  the  student  should  be  familiar  with. 

(a)  State  clearly  what  is  the  precise  point  which  the  author 
seems  to  be  trying  to  make. 

(b)  Show  that  it  is  unsound. 

3.  At  a  certain  time  the  price  of  whiskey  in  this  country  was 
about  fifty  cents,  the  cost  of  producing  it.  The  United  States 
government  thereupon  levied  on  each  gallon  produced  a  tax  of 

252 


CHAPTER  IX.     NORMAL   PRICE 

one  dollar.     What  naturally  happened  to  the  price  of  whiskey? 
Why? 

4.  From  a  cement  factory  promoter  in  1901:    "We  can  easily 
satisfy  any  fair-minded  person  that  our  proposition  is  a  veritable 
gold    mine.      Cement    can    be    put    on    the    market    by    a    well- 
equipped  mill  at  a  cost  of  about  $1.75  a  barrel,  while  it  is  selling 
for  $4,  thus  giving  a  profit  of  over  100  per  cent.    With  the  supply 
of   raw   material   practically   unlimited,    our   mill    will    soon    be 
turning  out  600,000  barrels  per  year,  and  our  annual  profits  will 
be  nearly  $1,500,000.     You  can't  afford  to  stay  out." 

Supposing  the  facts  to  be  as  stated,  what  economic  law  was 
overlooked  in  drawing  conclusions? 

5.  A  certain  residence  in  Ann  Arbor  is  taxed  each  year,  let 
us  say,  $42,  of  which  sum  $12  is  properly  chargeable  to  the  land 
while  the  remaining  $30  is  chargeable  to  the  house.     Under  the 
operation  of  the  two  principles  of  normal  price  which  we  have 
now  had,  the  $30  will  really  be  paid  by  the  tenant,  being  shifted 
from  the  landlord  to  him,  while  the  $12  will  not  be  shifted  and 
so,  as  far  as  the  future  is  concerned,  will  remain  on  the  land- 
lord. 

Explain  how  it  is  that  things  come  out  this  way. 

6.  ''Labor  once  spent  has  no  influence  on  the  future  value  of 
any  article." 

(a)  Show  that  this  is  true  as  applied  to  the  wooden  chair 
which  v/as  used  in  working  out  our  principle. 

(b)  Does  the  above  statement,  admitting  it  to  be  true,   in- 
validate our  principle  as  laid  down  on  page  247. 

7.  Suppose  that  the  rare  brand  of  tea  which  appears  in  Prob- 
lem 5,  page  190,  is  produced  in  China  and  that  the  Chinese  gov- 
ernment levies  a  tax  of  $50  a  pound  on  all  produced. 

(a)  What  effect  will  this  tend  to  have  on  its  price? 

(b)  Who  will  bear  the  burden  of  this  tax? 

(c)  Construct  an  output  schedule  under  which  the  tax  would 
raise  price. 

8.  Suppose  pur  government  levies  a  tax  of  $1  per  barrel  on 
the  cement  which  figures  in   Problem   i,  page  251.     Where  will 
the  burden  of  this  tax  tend  to  rest?     Prove. 

9.  At  a  certain  time  buggies  of  a  certain  type  are  selling  at 
$65,  the  cost  of  production  to  makers  working  with  the  poorest 
facilities.     At  the  same  time  other  classes  of  producers  can  get 
these   buggies    out    in   practically   unlimited   quantities    at   costs 
ranging  all  the  way  down  to  $35.     What  price  must  in  the  long 
run  tend  to  be  established?     Why? 

10.  Suppose  that  the  buggies  which  appear  in  the  last  prob- 
lem go  out  of  style  so  generally  that  the  number  already  man- 
ufactured   considerably   exceeds   the   demand    at  the   cost   price. 
What  will  the  price  of  these  buggies  tend  to  be  under  this  new 
condition?    Explain. 

253 


PRINCIPLES  OF  ECONOMICS   - 

Section  F.     Normal  Price  of  Increasing-Cost  Goods. 

We  have  disposed  of  the  first  sub-class  of  variable-supply 
goods,  constant-cost  goods;  we  pass  now  to  the  second  sub-class, 
increasing-cost  goods.  As  already  brought  out  in  Section  C,  the 
supply  schedule  of  these  goods  is  an  increasing-price  schedule, 
and  usually  regular.  Combining  this  fact  with  the  fact  set  forth 
at  the  close  of  Section  C,  that  practically  all  general  demand 
schedules  are  of  the  typical  form — showing  a  demand  which  va- 
ries inversely  as  price, — it  follows  that  the  principle  laid  down  on 
page  221  for  the  price  of  goods  having' this  type  of  schedule  ap- 
plies to  this  case  of  increasing-cost  goods.  That  is,  the  price  of 
such  goods  must  tend  to  be  one  which  coincides  at  once  with  the 
marginal  demand  price  and  the  marginal  supply  price.  But, 
again,  as  was  brought  out  in  Section  C,  the  supply  prices  of 
a  commodity  of  this  class  are  the  different  marginal  costs  of 
production,  while  the  demand  prices  are  expressions  of  the 
marginal  significances  of  the  several  amounts  given  in  the  sched- 
ule. It  follows,  therefore,  that,  in  our  formula  from  page  221, 
we  may  substitute  for  the  phrase  "marginal  supply  price"  the 
phrase  "marginal  cost"  and  for  the  phrase  "marginal  demand 
price"  the  phrase  "marginal  significance."  Accordingly,  our 
principle  for  this  case  of  increasing-cost  goods  is  as  follows. 
/  Principle.  The  normal  price  of  increasing  cost  goods,  the 
Continued  production  of  which  is  demanded,  tends  to  be  a  price 

/which   both   expresses   the   marginal  significance   of   the   output 

I  and  equals  its  normal  marginal  cost. 

Note :  In  the  above  formula  the  word  "normal"  is  inserted 
before  marginal  cost  to  anticipate  an  objectionable  interpretation 
which  some  have  made.  It  is  this  that  the  marginal  cost  is 
literally  the  greatest  cost  at  which  production  is  being  carried 
on,  including  cost  to  producers  who  are  quite  behind  the  times 
in  methods  and  facilities  and  are  perhaps  losing  money  all  the 
time  but  have  no  other  alternative  than  going  on  until  they  are 
completely  bankrupt.  Such  persons  are  not  marginal  producers 
in  any  proper  sense.  They  are  wholly  abnormal  elements,  hav- 
ing little  or  no  significance  in  the  case.  Since  by  hypothesis  they 
do  not  quit  production  when  it  becomes  unprofitable,  their  cost 
is  not  a  determining  factor  in  respect  to  price. 

Caution:  If  either  or  both  of  the  schedules  involved  in  the 
case  here  considered  are  more  or  less  discontinuous,  price  will 
not  necessarily  coincide  exactly  with  either  marginal  significance 
or  marginal  cost;  but  it  will  be  in  so  far  fixed  by  both  of  these 
that,  on  the  one  hand,  it  must  not  go  above  the  marginal  sig- 

254 


CHAPTER  IX.     NORMAL   PRICE 

nihcance  nor  down  to  the  first  extra-marginal  significance,  while, 
on  the  other  hand,  it  must  not  go  below  the  marginal  cost  nor  up 
to  the  first  extra-marginal  cost. 

To  illustrate  this  principle,  let  us  suppose  that  the  accompany- 
ing table  represent  sthe  same  portion  of  each  of  three  different 


Demand 

Price 

Supply 

000,000  oz 

cents 

000,000  oz 

Sch.D' 

"  Sch.D" 

Sch.D' 

Sch.D 

. 

Sch,S 

Sch.S' 

Sch.S" 

Sch,S"' 

210 

190 

230 

210 

60 

310 

330 

290 

270 

22O 

200 

240 

220 

59 

300 

320 

280 

260 

230 

210 

250 

230 

58 

200 

310 

270 

250 

240 

220 

260 

240 

57  . 

280 

300 

260 

240 

240 

230 

270 

250 

56 

270 

290 

250 

240 

240 

240 

280 

260 

55 

200 

280 

240 

240 

240 

250 

290 

270 

54 

250 

270 

230 

240 

240 

260 

300 

280 

53 

240 

260 

220 

240 

250 

2/0 

3io 

200 

52 

230 

250 

210 

230 

270 

200 

330 

310 

50 

210 

230 

100 

210 

260 

280 

320 

300 

5i 

220 

240 

200 

220 

normal  supply  schedules  and  three  different  normal  demand 
schedules  for  silver.  Combining  Schedule  S  with  Schedule  D, 
it  is  evident  that  price  must  tend  to  be  55  cents,  since  only  this 
price  secures  equality  of  demand  and  supply.  Further,  this 
price  of  55  cents  expresses  the  marginal  significance  of  silver, 
and  the  next  price  above,  56  cents,  equals  the  first  extra- 
marginal  cost.  So,  also,  this  price  of  55  cents  equals  the 
marginal  cost  of  producing  silver,  and  the  next  price  below,  54 
cents,  expresses  the  first  extra-marginal  significance.  That  is,price 
appears  to  ibe  fixed  in  its  position  by  each  of  the  four  determinants 
which  were  discussed  in  the  last  section  of  the  preceding  chap- 
rer.  Price  is  fixed  as  low  as  55  cents,  because  that  price  is  the 
marginal  demand  price  and  because  the  next  higher  one  is  the 
first  extra-marginal  supply  price.  So,  price  is  kept  as  high  as 
55  cents,  because  that  price  is  the  marginal  supply  price,  and 
because  the  next  lower  one  is  the  first  extra-marginal  demand 
price.  If,  now,  we  combine  Supply  Schedule  S  with  the  second  and 
third  demand  schedules,  D'  and  D",  in  succession,  we  discover 
that  the  price  changes  each  time,  and  that  each  time  the  new 
price  fulfils  the  same  conditions  as  the  old  one; — that  is,  it  both 

255 


PRINCIPLES  OF  ECONOMICS 

expresses  the  marginal  significance  and  equals  the  marginal  cost, 
while  it  is  just  below  the  first  extra-marginal  cost,  and  just 
above  the  first  extra-marginal  significance.  In  like  manner,  if 
we  combine  demand  Schedule  D  with  the  other  supply  schedules, 
S'  and  S",  in  succession,  we  again  find  price  changes  each  time; 
and  further  the  new  price,  as  before,  coincides  with  the  mar- 
ginal significance  and  also  the  marginal  cost  of  production,  and 
is  just  below  the  first  extra-marginal  cost  and  just  above  the 
first  extra-marginal  significance. 

The  fact  just  brought  out  that,  in  the  case  before  us,  every 
change  in  either  the  supply  schedule  or  the  demand  schedule 
promptly  brings  about  a  change  in  price  and  that  the  new  price 
in  each  case  fulfils  the  conditions  of  bearing  a  certain  relation 
to  the  marginal  and  first  extra-marginal  significances  and  a  cer- 
tain relation  to  the  marginal  cost  and  first  extra-marginal  costs, 
would  seem  to  prove  conclusively  our  contention  that,  in  the  case 
considered,  marginal  cost  and  marginal  significance  are  both 
playing  a  vital  part  in  price-determination.  But  I  am  tempted  to 
try  to  establish  this  point  still  more  thoroughly,  in  view  of  the 
fact  that  one  group  of  writers  are  wont  to  insist  that,  in  this  and 
all  cases  of  producible  goods,  price  is  really  determined  by  mar- 
ginal significance  only, — cost  merely  adjusting  itself  to  a  price 
thus  determined ;  while  another  group  is  wont  to  insist  that,  in 
all  cases  of  producible  goods,  price  is  really  determined  by  mar- 
ginal cost  only, — marginal  significance  merely  adjusting  itself 
to  a.  price  thus  determined  Now,  there  can  be  no  doubt  that  it 
is  possible  to  have  cases  with  respect  to  which  it  can  properly 
be  affirmed  that  significances  or  utilities  only  are  determining 
price  while  marginal  cost  in  adjusting  itself  to  a  price  thus  de- 
termined. So,  also,  it  is  possible  to  have  cases  with  respect 
to  which  it  can  properly  be  affirmed  that  costs  only  are  determin- 
ing price,  while  marginal  significance  or  utility  is  adjusting 
itself  to  a  price  thus  determined.  Section  D  gave  us  a  product 
of  the  first  sort  in  the  rare  brand  of  tea ;  while  Section  E  gave 
us  one  of  the  second  sort  in  our  wooden  chair.  But  the  case 
before  us  surely  does  not  belong  to  the  same  class  as  either  of 
these.  The  test  used  to  determine  the  matter  in  the  case  of  the 
tea  was  to  change  that  part  of  the  cost  schedule  which  included 
the  actual  price  by  making  supply  constant  for  a  space  both  be- 
low and  above  said  price, — thus  insuring  that  actual  price  should 
not  coincide  with  marginal  cost  unless  the  former  was  changed 

25G 


CHAPTER  IX.     NORMAL   PRICE 

by  the  change  in  conditions.  Since  actual  price  was  not  thus 
changed  and,  so,  did  not  coincide  with  marginal  cost,  we  had  to 
conclude  that  cost  was  not  playing  a  necessary  role  in  the  de- 
termination of  actual  price.  In  the  case  of  the  chair,  on  the 
other  hand,  we  made  a  similar  hypothetical  change  in  the  de- 
mand schedule,  by  which  change  it  became  constant  for  a  space 
both  above  and  below  the  price  corresponding  to  the  actual  price, 
—thus  making  it  impossible  for  actual  price  to  coincide  with 
marginal  significance,  unless  the  former  was  changed  by  the 
change  in  conditions.  Since  actual  price  was  not  thus  changed 
and,  so,  did  not  coincide  with  the  marginal  significance,  we  had 
to  conclude  that,  in  the  case  considered,  marginal  significance 
was  not  playing  a  part  in  price-determination.  Now,  if  tests 
similar  to  these  be  applied  to  the  case  before  us,  the  results  will 
be  quite  different.  If,  for  example,  starting  with  Schedule  D 
we  make  demand1  constant  from  57  cents  down  to  53  cents,  ,as  in 
Schedule  D'" — the  supply  schedule  used  in  both  cases  being 
S — ,  the  actual  price  promptly  drops  to  53  cents,  show- 
ing that  demand  prices  and,  so,  the  significances  or  utilities  which 
they  express  were  playing  a  part  in  fixing  our  original  price  of  55 
cents.  Again,  we  get  similar  re-stilts,  if  we  try  a  similar  ex- 
periment with  the  supply  schedule.  Thus,  if,  starting  with 
Schedule  S,  we  make  supply  constant  from  53  cents  to  58  cents, 
— the  demand  schedule  use  in  both  cases  being  D1 — ,  actual 
price  promptly  rises  to  57  cents,  showing  that  supply  prices, 
costs  of  production,  were  playing  a  part  in  fixing  our  original 
price  of  55  cents. 

Note:  In  the  preceding  discussion  I  have  insisted  upon  af- 
firming that  normal  price  must  both  equal  marginal  cost  and 
express  marginal  significance.  But  it  is  possible  to  argue  that, 
in  making  up  a  formula,  either  one  of  these  determinants  might 
be  chosen  and  the  other  omitted,  on  the  ground  that  either 
implies  the  other.  That  is,  it  might  be  sufficient  to  say  that  the 
normal  price  of  such  goods  must  equal  their  marginal  cost  of 
production, — not  mentioning  marginal  significance — ,  for  the 
reason  that  no  marginal  cost  of  production  could  be  settled  upon 
until  one  had  been  reached  which  coincided  with  marginal  sig- 
nificance. So,  on  the  other  hand,  it  might  be  sufficient  to  say 
that  the  normal  price  of  goods  of  this  class  must  equal  their 
marginal  significance, — not  mentioning  marginal  cost — ,  for  the 
reason  that  said  marginal  significance  could  never  be  really 
settled  upon  until  one  had  been  reached  which  coincided  with 
marginal  cost.  In  other  words,  in  saying  either  of  these  things 
tve  necessarily  say  the  other.  No  doubt  this  is  true.  But  the 

257 


PRINCIPLES  OF  ECONOMICS 

objection  to  it  is  that,  if  we  affirm  the  relation  of  price  to 
either  of  these  making  no  mention  of  the  other,  there  is  always 
danger  that  we  shall  be  understood  to  mean  that  the  one 
we  do  mention  has  the  whole  work  in  its  'hands  to  the  exclusion 
of  the  other.  There  is  really  a  considerable  ellipsis  in  our  own 
statement  of  the  case.  That  is,  to  express  ourselves  with  pre- 
cision we  ought  to  say  that  the  normal  price  must  in  the  long  run 
be  as  low  as  the  marginal  utility  and  not  be  as  high  as  the  first 
extra-marginal  cost,  at  the  same  time  must  be  as  high  as  the  mar- 
ginal cost  and  must  not  be  as  low  as  the  first  extra-marginal  sig- 
nificance. In  the  opinion  of  the  writer,  anyhow,  it  is  unsafe  to 
carry  the  ellipsis  further. 

ILLUSTRATIVE  PROBLEMS. 

1.  Suppose  that  the  production  schedule  of  silver   reads  as 
follows :  at  a  marginal  cost  of  55  cents,  170  millions  ounces  can 
be  furnished ;  at  a  marginal  cost  of  56  cents,  175  millions  ounces ; 
at  57  cents,  180  millions;  at  58  cents,  185  millions;  at  59  cents. 
190  millions;  at  60  cents,  195  millions;  at  61  cents,  200  millions; 
at  62  cents,  205  millions ;  at  63  cents,  210  millions ;  etc.   Suppose, 
secondly,  that  the  demand  schedule  is  as  follows :    160  millions 
ounces  wanted,  if  price  is  65  cents;  165     millions,  if  price  is  64 
cents;  170  millions,  at   63  cents;  175  millions,  at  62  cents;    180 
millions,  at  61  cents;  185  millions,  at  60  cents;  190  millions,  at 
59  cents ;  195  millions,  at  58  cents ;  200  millions,  at  57  cents ;  etc. 

(a)  Make  out  a  table  giving  the  ultimate  demand  and  supply 
schedules. 

(b)  What  must  price  tend  to  be?     Prove. 

(c)  What  will  it  tend  to  be  if  demand  moves  up  two  steps, 
becoming:  170  millions  wanted  if  price  is  65  cents;  175  millions 
if  price  is  64  cents ;  and  so  on.    Prove. 

(d)  What  determines  price  in  these  two  cases? 

2.  "At  the  present  time  (1896)   silver  is  being  produced  at  a 
marginal  cost   of  approximately  65   cents   per   ounce.     But   the 
price  of  silver  is  in  the  long  run  determined  by  its  marginal 
cost.     Hence  it  is  ridiculous  to  expect  that  the  adoption  of  free 
coinage  by  the  United  States  will  raise  the  price  of  silver,  as 
measured  in  gold,  to  $1.29  per  ounce,  or  any  other  figure  above 
65  cents." 

Admitting  that  the  normal  price  of  silver  must  in  the  long 
run  coincide  with  marginal  cost,  still  the  above  conclusion  is 
unsound.  Explain. 

3.  Starting  with  Problem  1,  in  its  original  form,  suppose  that 
the  government  puts  on  every  ounce  of  silver  costing  less  than 
50  cents  a  tax  of  4  cents.    This  tax  will  of  course  be  paid  in  the 
first  instance  by  the  producers  of  silver. 

(a)  Will  it  be  borne  by  them  in  the  end  or  be  shifted  to 
consumers?     Give  the  argument. 
-    (b)  What  will  the  new  price  be? 

258 


CHAPTER  IX.     NORMAL   PRICE 

(c)   Compare  this  result  with  that  appearing  in   Problem  8, 
page  253. 

4.  Suppose  the  government  were  to  levy  a  tax  of  4  cents  per 
ounce  on  all  silver  produced ;  and  answer  the  same  questions  as 
tinder  Problem  3. 

5.  Suppose    the    production    schedule   in    Problem    1    to    be 
changed   so   as   to  read   as   follows:   at  a  marginal   cost  of   55 
cents,   175  millions  ounces  can  be  furnished;  between   55   cents 
and  59  cents  no  change  is  possible;  at  a  marginal  cost  of  59 
cents,  500   millions   ounces  can   be    furnished;   at  60  cents,    525 
millions  ounces;  and  so  on. 

(a)  What  would  price  tend  to  be  when  the  demand  schedule 
was  the  same  as  in  Problem  1  (b)  ?     Prove. 

(b)  What  would  price  tend  to  be   if   the   demand   schedule 
were  moved  up  as  in  Problem  1   (c)  ?    Prove. 

(c)  What  would  price  tend  to  be    if   the   demand  schedule 
were   moved  up  two   more  steps   so  as  to  begin:   190  mil.   oz. 
wanted  at  65c.  ?     Prove. 

(d)  What  is  the  point  to  be  made? 

6.  The  author  of  a  recent  text-book  in  Economics  expresses 
himself  on  the   relation  of  cost  to  price  in  this  vein:     In  the 
case  of  reproducible  goods,  "cost  of  production  seems  of  com- 
manding   importance.'      "In    fact,    however,    marginal    efficiency 
(utility)   is  the  real  determinant  of  price,"  "cost  of  production 
adjusts  itself  to  this."     "There  is  an  abundance  of  silver  below 
the  surface  that  is  not  mined  because  it   will  not  pay;  if  the 
marginal   efficiency   or  value  of  silver  should  rise,  these  more 
expensive  grades  would  at  once  be  marketed  and  the  new  mar- 
ginal cost  of  production  would  adjust  itself  to  the  price." 

(a)  Construct   a   sentence    running   parallel    to   the    last    one 
quoted,  but  exactly  reversing  the  roles   of  marginal  utility  and 
marginal  cost,  whereby  it  would  seem  to  be  proved   that   mar- 
ginal cost  really  determines  price  while  marginal  utility  merely 
adjusts    itself   to   price.     The   sentence   should    start    out   some- 
thing like  this  :     "Generally  speaking,  it  would  seem  as  if  mar- 
ginal utility  chiefly  regulated  price.     In  fact,  however,  marginal 
cost  is  the  real  determinant;  marginal  utility  adjusts  itself  to  this. 
Below  the  present  demand  for  silver  there  are  numerous  layers 
of  demand  which   are   now  merely  potential  because  the  corre- 
sponding utilities  are  below  the  present  market  price;  if,  now, 
the   marginal   cost  of  producing   silver  should    fall,   and   so   the 
price  should  fall,  these  lower  layers  of  demand,  etc.     .     .    ." 

(b)  Show  that  both  the  original  quotation   and  our  substi- 
tute are  inadequate.     Construct  imaginary  schedules  to  illustrate 
your  argument. 

Section  G.     Some  Special  Cases  of  Normal  Price. 

The   general    principles    governing    normal    price    have    been 
brought  out  in  the  preceding  section.     But  there  are  some  cases 


PRINCIPLES  OF  ECONOMICS 

which  need  to  be  recognized  as  special  cases  and  given  special 
treatment.  Some,  on  account  of  peculiar  complications,  are  not 
provided  for  at  all  in  the  preceding  matter.  Others  could  be 
fairly  covered  by  a  careful  interpretation  of  the  principles  al- 
ready laid  down;  but,  because  of  peculiarities,  unless  further 
explanation  is  given  there  is  danger  of  misunderstanding.  In 
still  other  cases,  there  is  reason  for  attempting  a  special  state- 
ment, because,  although  the  principles  already  laid  down  quite 
plainly  apply  to  the  case  under  consideration,  it  is  possible  for 
various  reasons  to  go  deeper,  to  find  some  more  ultimate  state- 
ment of  the  forces  determining  price  than  has  already  been 
brought  out. 

i.     Joint-Cost  Products. 

In  the  case  of  not  a  few  producible  goods,  we  strike  a  special 
complication  due  to  the  fact  that  several  different  commodi- 
ties emerge  from  the  same  productive  process.  Thus,  the  dairy- 
man is  more  or  less  responsible  for  the  production  of  milk, 
butter,  cheese,  beef,  and  hides.  In  our  day,  cases  of  this  sort 
have  increased  greatly  in  number  because  of  the  scientific  and 
industrial  development  which  has  made  possible  the  utilization 
of  so-called  by-products.  A  familiar  illustration  is  that  of  the 
refining  of  petroleum,  which  yield's  not  only  common  illuminat- 
ing oil,  kerosene,  but  also  vaseline,  gasolene,  naptha,  etc.  Again 
the  coal  tar  resulting  from  the  distillation  of  coal  for  the  mak- 
ing of  gas  gives  us  a  whole  line  of  by-products,  including  various 
drugs,  perfumes,  a  large  number  of  dyes,  etc.  Now,  it  is 
evident  that  in  cases  like  these  it  is  difficult,  if  not  impossible, 
to  isolate  the  share  in  the  cost  of  production  which  is  properly 
chargeable  to  each  of  the  several  products.  This  being  the  case, 
we  surely  cannot  apply  to  these  goods,  without  some  special 
qualification,  the  principle  which  has  been  laid  down  for  other 
producible  goods. 

The  special  theory  of  this  case  which  was  set  forth  by  'Mill  has 
been  in  general  accepted.  It  is  that  the  price  of  each  of  the  indi- 
vidual products  must  be  such  as  to  equalize  supply  and  demand 
for  fhat  product;  while  the  money  value  of  the  whole  group 
of  products  must  equal  their  cost  of  production.  In  consistency 
with  the  -modern  analysis  which  goes  behind  demand  to  sig- 
nificance or  utility,  we  should  slightly  modify  Mill's  formula, 
getting  it  into  the  following  shape. 

260 


CHAPTER  IX.     NORMAL   PRICE 

Principle.  The  price  of  each  member  of  a  group  of  joint- 
cost  products  tends  to  be  that  price  which  expresses  the  mar- 
ginal significance  or  utility  of  the  quantity  of  that  particular 
product  which  is  put  upon  the  market,  provided  that  the  sum  of 
the  money  values  of  all  products  of  the  group  tends  to  equal 
their  joint  cost  of  production. 

The  argument  in  support  of  this  principle  is  as  follows.  First,  \ 
as  respects  the  affirmation  that  the  price  of  each  member  of  \ 
each  group  of  products  must  'be  such  as  to  express  its  marginal 
significance,  this  follows  from  the  fact  that,  under  the  con- 
ditions given,  the  quantity  of  each  of  the  products  is  virtually 
fixed,  and  hence  it  comes  under  fixe  d-'sup  ply  goods.  This, 
of  course,  does  not  mean  that  the  supply  of  each  commodity  is 
literally  unchanging;  but  that  its  changes  do  not  take  place  in 
response  to  conditions  which  affect  that  commodity  itself  only, 
but  rather  in  response  to  conditions  which  affect  all  the  com- 
modities of  the  group.  Whenever,  therefore,  the  price  of  any 
one  of  them  is  in  process  of  determination,  the  supply  of  that 
particular  one  is  in  effect  a  fixed  supply;  and  'hence  the  prin- 
ciple governing  its  price  is  the  one  which  regulates  the  price  of 
fixed-supply  goods.  But  the  principle  in  question  makes  the 
regulation  of  price  for  these  goods  a  question  of  marginal  sig- 
nificance ;  and,  so,  marginal  significance  governs  the  case  before 
us. 

We  (have  seen  that  the  price  of  each  member  of  a  joint-cost 
group  must  be  determined  under  the  principle  governing  fixed- 
supply  goods,  that  is,  by  its  marginal  significance.  It  is,  how- 
ever, no  less  certain  that  the  prices  of  all  the  members  of  the 
group  must  be  such  that  the  sum  total  of  their  money  values 
will  equal  their  joint  cost  of  production.  This  result  is  bound  to 
be  brought  about  through  processes  already  thoroughly  familiar. 
If  at  any  point  the  sum  total  of  the  group  prices  rises  above  this 
total  cost  of  the  group  products,  capital  will  move  into  the  in- 
dustry involved,  supply  all  along  the  line  will  increase,  marginal 
significance  will  fall,  and  so  prices  will  fall.  Conversely,  if  the 
total  costs  are  not  covered  by  the  total  values,  capital  will 
withdraw  from  the  industry  involved,  the  supply  of  the  several 
commodities  will  fall  off,  their  marginal  significance  will  rise, 
and  so  prices  will  rise.  Doubtless  the  process  whereby  this  re- 
sult is  brought  about  would  be  much  more  complicated,  and 
hence  much  slower,  than  in  the  case  of  isolated  individual  prod- 

261 


PRINCIPLES  OF  ECONOMICS 

ucts.     It   is   certain,  however,   that,   in   the   long   run,   the   read- 
justment described  would  be  brought  about. 

ILLUSTRATIVE  PROBLEMS. 

1.  Enumerate    some    products    of    a    Michigan    farm    which 
might  be  thought  of  as  by-products. 

2.  Discuss    the    question    as    to    whether    the    transportation 
between    Detroit    and    Jackson    of    products    of    quite    different 
types,  for  example,  coal  and  dry  goods,  truly  gives  rise  to  a  case 
of  joint-cost  products. 

2.     Diminishing-Cost  Goods. 

If  the  wooden  chair,  the  output  schedule  of  which  was  pre- 
sented in  Chapter  4,  page  121,  is  taken  in  the  earlier  stages  of  this 
output  schedule,  it  gives  us  a  case  of  diminishing-cost  goods ; 
that  is,  in  that  stage  the  more  output  producers  try  to  furnish, 
the  smaller  is  the  cost  per  unit.  This  case  we  sometimes  treat 
as  giving  us  a  third  sub-division  of  variable-supply  goods.  But 
this  procedure  is  hardly  justifiable  for  the  reason  that,  in  lay- 
ing down  any  scientific  principle,  we  assume  conditions  to  be 
substantially  unchanging  and  hence  the  general  principle  that 
price  tends  to  equal  cost,  if  properly  interpreted,  is  really  ade- 
quate for  this  case.  That  is,  said  principle  is  adequate,  provided 
we  remember  that  the  cost  of  production  which  is  meant  in 
our  principle  is  the  cost  which  is  representative  at  the  very 
time  involved  not  at  an  earlier  or  a  later  date.  Nevertheless, 
as  this  case  is  one  of  considerable  practical  importance,  it  seems 
to  deserve  same  comment.  Hence  we  give  it  a  place  among 
these  special  cases. 

The  theory  of  this  case  is  comparatively  simple.  So  long  as 
the  demand  for  commodities  such  as  we  are  considering  is  still 
relatively  small,  persons  producing  them  are  obliged  to  employ 
expensive  methods  of  production,  and,  hence,  cost  and,  so,  price 
is  high.  Presently,  demand  shows  a  large  increase ;  and,  in 
consequence,  producers  are  able  to  realize  the  various  gains 
of  large-scale  production,  with  the  result  that  cost,  and,  so, 
price  is  greatly  diminished.  Accordingly,  if  we  wish  to  look 
at  the  period  which  includes  these  changes  as  a  totality  and  state 
the  law  which  governs  that  period  as  a  totality,  we  have  to  say 
that  price  tends  to  equal  the  lowest  of  the  costs  of  production. 
Put  into  formal  shape,  this  gives  us  the  following: 

262 


CHAPTER  IX.     NORMAL   PRICE 

Principle.  The  price  of  diminishing -cost  goods  tends  to 
equal  their  cost  to  producers  ivorking  on  the  largest  scale  justi- 
fied by  the  existing  conditions  of  demand, — monopoly  being 
excluded. 

Note :  This  principle  is  of  much  practical  importance  in 
connection  with  the  theory  of  investment.  In  the  earlier  stages 
of  a  new  industry,  while  primitive  methods  are  being  employed, 
price  will  be  so  high  that  producers  who  are  intending  to  intro- 
duce improvements  which  will  greatly  reduce  cost,  are  wont 
to  anticipate  therefrom  enormous  profits,  and  perhaps  will  at- 
tempt to  attract  investors  'by  representations  to  this  effect.  It 
is,  however,  the  business  of  the  prospective  investor  to  remem- 
ber that,  just  because  it  is  going  to  be  possible  to  reduce  cost 
of  production,  the  price  itself  is  bound  to  fall,  and  the  great 
prospective  profits  which  are  being  pictured  by  promoters  will, 
in  all  likelihood,  fail  to  put  in  an  appearance. 


3.    'Fixed-Supply  Income-Bearers. 

Another  special  case  which  is  of  considerable  importance  is 
furnished  by  the  fixed-supply  income-bearer,  for  example,  a. 
piece  of  land  rented  for  business  purposes.  Taking  up,  first, 
the  case  of  income-bearers  in  general,  we  remark  that,  between 
the  price  of  such  an  income-bearer  and  its  income,  there  must 
tend  to  prevail  at  all  times  a  fixed  ratio  approximately  equal 
to  the  current  rate  of  interest.  Supposing  that,  under  the  opera- 
tion of  various  economic  forces  not  here  to  be  discussed,  the 
rate  of  interest  on  money  loans  is  approximately  5%,  then,  be- 
tween the  price  of  an  automobile,  let  us  say,  which  is  to  be  used 
for  purposes  of  hire  and  the  net  money  income  derived  from 
said  automobile, — due  allowance  having  been  made,  in  reckon- 
ing the  net  income,  for  repairs,  replacement,  labor  services,  and 
so  on, — the  ratio  is  bound  to  be  approximately  100  to  5  or  20 
to  i.  Now,  the  establishment  of  this  ratio  may  conceivably 
be  brought  about  in  either  of  two  ways:  (i)  the  price  of  the 
automobile  having  been  fixed,  the  income  may  move  up  and 
down  till  it  settles  at  a  point  which  makes  it  just  1/20  of  said 
price  of  the  automobile,  or  (2)  the  income  having  been  fixed, 
the  price  of  the  automobile  may  move  up  and  down  till  it  settles 
at  a  point  just  20  times  as  great  as  the  income.  Now  which  will 
it  be?  This  depends  surely  on  which  of  the  two  things,  the  in- 
come or  the  price  of  the  auto,  is  free  to  move,  and  so  able  to  put 
itself  in  the  required  relation  to  the  other.  In  the  oase  of  the  auto- 

263 


PRINCIPLES  OF  ECONOMICS 

mobile,  the  one  which  must  do  this  is  surely  the  net  income ;  for,  as 
we  have  just  remarked,  the  price  is  fixed  by  cost  of  production 
and  so  is  not  able  to  move  at  all.  The  income,  however,  finds 
no  difficulty  moving.  If  the  net  incomes  derived  from  renting 
automobiles  are  too  large  considering  the  price  of  machines. 
then  competition  will  increase,  and  rentals,  and  so  incomes,  will 
decline.  If  incomes  are  too  small,  competition  will  fall  off, 
and  rentals,  and  so  incomes  will  increase.  Accordingly  in  the 
case  of  producible  income-bearers,  the  price  of  the  income- 
bearer  is  first  fixed  and  to  this  price  the  net  income  is  ad- 
justed.* 

Passing,  now,  to  the  case  of  non-producible  income-bearers 
such  as  land,  we  find  ourselves  facing  a  very  different  problem. 
Here  there  is  no  cost  to  come  into  the  matter.  Utility  only  can 
affect  price ;  and  the  particular  utility  which  has  to  be  con- 
sidered is  quite  obviously  the  service  given  off  by  the  land  for 
a  certain  definite  time.  That  is,  the  first  thing  to  be  fixed  is, 
not  the  price  of  the  land  as  a  whole,  but  the  price  of  a  year's 
use  of  the  land,  i.e.,  its  income;  which  income,  having  been 
fixed,  determines  in  some  way  the  price  of  the  land  itself.  But 
here  again,  as  in  the  case  of  producible  income-bearers,  the 
relation  between  the  price  of  any  particular  income-bearer  and 
its  income  is  fixed  in  advancef  by  the  existing  ratio  between 
capital  in  general  and  the  income  therefrom.  When  5  per  cent 
is  the  prevailing  rate  of  interest,  we  can  be  pretty  sure  that 
the  net  yearly  income  of  a  piece  of  ground  which  commands 
a  price  of  $1,000  must  be  about  $50.  So  far  the  case  of  the 
piece  of  ground  and  the  automobile  are  alike.  But,  when  it 
comes  to  causation,  the  cases  are  quite  different.  The  income 
of  the  machine  adjusts  itself  to  its  price  or  cost;  the  price  of 


*The  student  must  remember,  however,  that  the  price  of  constant-cost 
goods  is  not  always  governed  by  cost.  A  necessary  condition  was  ex- 
pressed in  the  phrase,  "the  continued  production  of  whi>h  is  demanded." 
which  appears  in  the  formula  on  page  247  Producible  income-bearers  at 
times  pass  into  the  status  of  non-producible  ones.  But  these  exceptional 
cases  will  be  considered  later. 

•}•  This  is  not  to  say  that  the  particular  case  under  consideration  plays  no 
part  in  determining  the  ratio  between  capital  in  general  and  the  income 
therefrom.  Doubtless  every  transaction  involving  an  exchange  of  present 
wealth  for  the  right  to  a  series  of  future  incomes  has  some  share  in  fixing 
the  rates  at  which  such  exchanges  take  place.  But,  as  we  have  already 
seen,  the  price-making  forces  come  to  a  head,  so  to  speak,  in  a  particular 
class  _  of  transactions,  viz.,  those  which  are  marginal, — those  in  which 
marginal  utility  or  marginal  cost  or  both  are  determined.  Accordingly,  we 
can  safely  treat  almost  any  particular  transaction  involving  the  exchange 
of  present  wealth  for  a  series  of  future  incomes  as  one  to  which  is  being 
applied  a  ratio  of  exchange  which  has  alreadv  been  determined  elsewhere. 

264 


CHAPTER   IX.     NORMAL   PRICE 

the  land  adjusts  itself  to  its  income.  We  can  not  say:  the  land 
is  worth  $1,000,  hence  its  net  income  must  be  $50.  Rather,  we 
must  say :  the  net  income  of  the  land  is  $50,  hence  its  value 
must  be  about  $1,000.  If,  now,  we  formulate  the  point  brought 
out  in  the  preceding  discussion,  we  have  the  following 

Principle.  The  price  of  an  income-bearing  property  not 
capable  of  duplication  tends  to  equal  the  sum  of  money  which 
lent  at  the  current  rate  of  interest  would  yield  a  yearly  income 
equal  to  the  net  yearly  income  of  the  said  property. 

Illustration.  Suppose  a  certain  building  site  regularly  yields 
a  net  income  of  $100,  and  that  the  current  rate  of  interest  on 
long-time  loans  is  about  5  per  cent.  Then,  the  price  of  the  site 
will  tend  to  be  as  many  dollars  as  .05  is  contained  in  100,  i.e., 
$2,000.  (The  usual  procedure,  when  5  per  cent  is  the  rate,  is 
to  multiply  the  income  by  20,  which  is  the  same  thing  as  divid- 
ing it  by  .05,  since  five  hundredths  equal  one-twentieth.) 

ILLUSTRATIVE  PROBLEMS. 

1.  If  a   certain   mining  stock  pretty  generally  yields  a  net 
income  each  year  of  $54  per  share,  what  would  its  price  tend 
to  be,  supposing  that  the  usual  rate  of  return  expected  in  such 
lines  of  industry  is  about  7  per  cent?     Prove. 

2.  If  the  dividend  of  the  above  stock  fell  to  $37,  what  would 
you  expect  the  price  of  the  stock  to  become? 

3.  Suppose  you  are  considering  the  purchase  of  a  $100  gov- 
ernment bond,  untaxed  and  paying  2  per  cent  interest.     What 
price  could  you  reasonably  pay,  if  the  rate  commonly  obtained 
on  securities  of  this  grade  was  1.9  per  cent?     Prove. 

4.  Here  is  a  piece  of  farm  land  which   regularly  yields  a 
net  income  of  $1,700.     What  would  its  price  tend  to  be  when 
the  rate  of  interest  in  such  lines  was  about  5.5  per  cent? 

5.  Here  is  a  site  in  a  large  city  which  yields  a  ground  rent 
of  $51,000  a  year.     Suppose  that  the'  Henry  George  ideas  came 
to  prevail  in  said  city,  so  that  the  tax  on  the  site  named  is  fixed 
at  93  per  cent  of  its  rent. 

(a)  What  would  the  price  of  the  site  tend  to  be  when  the 
rate  of  interest  was  about  5  per  cent? 

(b)  What  would  it  be  if  the  rate  of  taxation  were  raised  to 
100  per  cent,  the  rate  of  interest  remaining  5  per  cent? 

6.  Supposing  that   there   were   no   interfering   causes,    what 
would   you   expect   the   price   of   a   government   bond   bearing   2 
per  cent  interest  to  do  in  times  like  these   (summer  1907)   when 
the    rate    of    interest    has    been    exceptionally    high    for    many 
months? 

7.  A  certain  building  site  regularly  yields  a  net  income  of 

265 


PRINCIPLES  OF  ECONOMICS 

$300  a  year.  This  fact  would  cause  it  to  have  what  market 
value  when  the  rate  of  interest  was  8  per  cent?  6  per  cent? 
5  per  cent? 

8.  A  certain  automobile  which  is  hired  out,  regularly  yields 
its  owner  a  clear  income  over  all  expenses  of  about  $300  per 
year.     With  interest   at   6  per  cent,   this   fact  would  cause  the 
car  to  have  what  market  value?     Is  this  a  reasonable  problem? 

9.  An   automobile   costs  $1,200  and  lasts   only  three  years. 
With  interest  .at  6  per  cent  and  with  6  per  cent  added  for  the 
trouble   and  risk  of  running  an  automobile  livery,  what   must 
an  automobile  earn  during  a  year  to  make  the  business  pay? 

10.  A  certain  building  site  is  worth  $22,000.     With  interest 
at  6  per  cent,  what  surplus  over  other  expenses  must  any  busi- 
ness located  on  the  given  site  pay  in  order  to  make  the  use  of 
the  site  for  that  purpose  profitable?     Is  this  a  legitimate  prob- 
lem? 

Section  H.     Normal  Price  Under  Monopoly. 

The  preceding  discussion  of  price  has  been  carried  forward 
on  the  assumption  that  there  is  free  competition  among  pro- 
ducers or  sellers.  But  the  student  is  of  course  aware  of  the 
fact  that  such  free  competition  is  by  no  means  universal.  Sub- 
stantially the  whole  output  or  stock  of  not  a  few  kinds  of 
goods  is  in  the  exclusive  control  of  a  single  natural  or  legal 
person.  Such  a  condition  of  things  is  known  as  a  monopoly. 
The  person  having  such  exclusive  control  of  stock  or  output  is 
said  to  have  a  monopoly.  That  the  presence  of  monopoly  would 
tend  to  alter  the  conditions  determining  normal  price  wuld  be 
admitted  by  every  one.  Indeed,  it  is  probable  that  most  people 
think  of  monopoly  as  doing  away  with  all  normality  in  price. 
The  monopolist  is  often  supposed  to  fix  price  in  a  purely  arbi- 
trary way.  This,  however,  is  going  quite  too  far.  Monopoly 
prices,  though  less  submissive  to  natural  laws  than  competitive 
prices,  are  not,  after  all,  altogether  free  from  such  laws.  The 
monopolist  is  coerced  by  the  conditions  of  the  case  into  fixing 
his  prices  so  that  they  conform  to  certain  broad  principles. 

In  the  first  place,  it  is  easy  to  show  that  the  monopolist 
can  put  prices  so  high  as  to  make  his  gains  smaller  than  they 
would  have  been  if  he  had  set  his  price  lower.  Thus,  suppose 
that  petroleum  is  a  monopolized  product,  and  that  a  section  of 
its  demand  schedule  is  as  follows:  1,900  millions  gallons  want- 
ed if  price  is  9  cents;  2,500  millions  if  price  is  8  cents;  3,000 
millions  if  7  cents;  4,000  millions  if  6  cents;  and  so  on.  Sup- 

266 


CHAPTER  IX.     NORMAL   PRICE 

pose,  further,  that  the  total  cost  per  gallon  is  4  cents,  so  that 
there  is  a  clear  profit  of  5  cents  per  gallon  if  the  selling  price  is 
9  cents;  of  4  cents  per  gallon  if  price  is  8  cents;  and  so  on. 
If,  under  these  circumstances,  the  monopolist  fixes  the  price  at 
9  cents,  he  will  clear  $95,000,000,  whereas  at  8  cents  he  would 
have  cleared  $100,000,000.  What  he  gains  through  larger  profit 
on  each  unit  of  product  he  will  more  than  lose  by  diminishing 
the  total  number  of  units  sold. 

On  the  other  hand,  it  would  be  foolish  for  the  monopolist 
to  go  to  the  opposite  extreme  in  carrying  out  a  policy  of  lowering 
price  in  order  to  increase  demand.  Thus,  if  he  puts  the  price 
down  to  7  cents,  he  will  indeed  cause  demand  to  increase  from 
1,900  millions  to  3,000  millions;  but  the  lowering  of  profit  on 
each  unit  will  more  than  offset  this  gain  in  amount  sold.  His 
net  profit  will  drop  to  $90,000,000.  In  short,  the  self-interest  of 
the  monopolist  will  dictate  that  he  fix  on  the  price  which  in- 
sures that  the  product  of  the  net  profit  per  unit  output  into 
total  output  is  the  highest  possible;  and  this  gives  us  the  gen- 
eral principle  determining  normal  price  for  cases  of  strict  mo- 
nopoly. 

Principle.  Broadly  speaking,  the  normal  price  of  any  mo- 
nopolized commodity  tends  to  be  that  price  which  will  secure 
the  largest  net  return  to  the  monopolist. 

A  cursory  examination  of  the  preceding  analysis  of  a  case 
of  monopoly  shows  plainly  that  the  cause  which  hindered  the 
monopolist  from  pushing  price  upward  indefinitely  was  the 
fact  that  as  price  rose  demand  fell  off, — in  other  words,  demand 
was  elastic,  varying  inversely  as  price.  If  demand  had  dimin- 
ished more  rapidly  with  increase  in  price,  the  price  actually 
established  would  have  been  still  nearer  cost  of  production.  If 
demand  had  changed  less  rapidly  with  increase  in  price,  price 
would  have  been  put  still  farther  above  cost  of  production. 
Hence  the  following 

Corollary.  The  tendency  of  monopoly  price  to  rise  above 
the  competitive  normal  varies  inversely  as  the  elasticity  of  the 
demand  for  the  monopolized  commodity. 

It  obviously  follows  from  this  corollary  that  every  cause 
which  increases  the  elasticity  of  the  demand  for  a  given  com- 
modity diminishes  the  tendency  of  price  in  said  case  to  separate 
from  the  competitive  normal.  Thus,  the  coming  out  of  a  com- 

.267 


PRINCIPLES  OF  ECONOMICS 

modity  which  can  be  used  as  a  substitute  for  some  monopolized 
one  diminishes  our  dependence  on  the  latter  and  so  makes  its 
demand  schedule  more  elastic. 

The  preceding  discussion  of  normal  price  under  monopoly 
has  brought  out  the  general  principle  governing  this  case.  But 
it  is  possible  to  be  a  little  more  specific  in  the  case  of  one  par- 
ticular type  of  monopoly  which  has  much  prominence  in  our 
day.  This  is  known  as  the  capitalistic  monopoly.  Such  a  mo- 
nopoly is  one  which  owes  its  origin  to  the  control  by  the  monop- 
olist of  an  exceptional  volume  of  capital.  Such  a  condition 
enables  a  man  or  group  of  men  to  attain  the  position  of 
monopolist,  to  gain  and  maintain  exclusive  control  of  output, 
largely  because  it  enables  said  man  or  group  of  men  to  pro- 
duce more  cheaply  than  rivals  and  hence  drive  them  out  of 
business*  But  it  is  plain  that  to  succeed,  monopolies  of  this 
sort  must  keep  prices  fairly  low, — somewhere  in  the  neighbor- 
hood of  cost  to  outsiders;  since  otherwise  competitors  will  be 
continually  starting  up,  which  competitors  will  have  to  be  bought 
out  at  considerable  cost  or  driven  out  by  destructive  commer- 
cial wars.  Formulating  this  point,  we  have  the  following 

Principle.  The  normal  price  of  goods  produced  by  capital- 
istic monopolists  tends  to  approximate  a  figure  not  much  above 
cost  of  production  to  outsiders. 

ILLUSTRATIVE  PROBLEMS. 

1.  Suppose  the  demand  schedule  for  Milton's  autographs  is 
as  follows:     1  wanted  at  $200;  2  at  $175;. 4  at  $150;  5  at  $140; 
8  at  $125;  9  at  $110;  12  at  $100;  13  at  $90;  15  at  $75;  and  20 
at  $50. 

(a)  If  there  came  on  the  market  9  autographs,  what  price 
would  they  tend  to  have  under  free  competition? 

(b)  What  price  if  all  were  owned  by  one  man? 

(c)  Answer   the    same   questions,   supposing  the    number   of 
autographs  to  be  15. 

(d)  Answer  the   same   questions,   supposing   the   number   to 
be  20. 

2.  When  the  United  States  Steel  Company  was  fully  organ- 
ized,   many   independent   producers    desired    the   Trust   to    join 
with  them  in  raising  the  prices  of  steel  products.     The  authori- 
ties  of  the  Trust,  however,   refused,   thinking   it   expedient  to 
maintain  the  old  level.     What  do  you  suppose  was  the  reason? 

3.  Suppose  that  in  the  "tea"  problem,  page  246,  one  of  the 


*Of  course  this  is  not  the  whole  story. 
268 


CHAPTER  IX.     NORMAL   PRICE 

conditions  had  been  a  monopoly  of  the  production  of  this  brand 
of  tea.   What  then  would  the  price  have  tended  to  be? 


Miscellaneous  Problems  in  Price. 

1.  There  come  on  the  market  eleven  specimens  of  a  certain 
rare  object  to  be  disposed  of  at  the  best  price  attainable.  If  the 
demand  is  as  follows:  1  wanted  at  $65;  2  more  at  $60;  4  more 
at  $50;  5  more  at  $45;  6  more  at  $40;  etc.,  what  price  will  tend  to 
be  reached?  Prove. 

2.  In  (he  last  problem,  suppose  a  tax  of  $5  to  be  levied  on 
each  specLren  sold. 

(a)     What  effect  on  price  would  be  produced? 
(b)     Who  would  bear  the  tax  in  the  end? 

3.  In  seating  the  principle  that  the  prices   of  goods  tend  to 
equal  their  money  cost  of  production,  some  writers  prefer  to  say 
"cost  of  rrproduction." 

(a)  Why  do  you  suppose  they  have  this  preference? 

(b)  Show  that,  on  the  assumption  implied  in  the  very  idea 
of  normal  price,  the  change  from  "cost  of  production"  to  "cost 
of  reproduction"  is  at  least  unnecessary. 

4.  "If  the  state  should  inaugurate  the  policy  of  levying  cu 
the   livery  business   a   10-per-cent   income   tax,   the   value   of   all 
plants  devoted  to  this  business  would  necessarily  fall  off  10  per 
cent."      Criticise. 

5.  "Every  owner  of  a  railroad,  of  a  patent,  of  a  book,  or  of 
a   (monopoly)    property  of  any  kind,  finds  that  he  makes  more 
money  by  putting  prices   down   to   figures   that    are   reasonable, 
that  is,  to  figures  which  correspond  to  the  values  to  the  buyers 
of    the    things    sold,    than    by    keeping    them    up    beyond    those 
figures." — Stickney. 

(a)  Show  that  the  words  "which  correspond  to  the  values 
to  the  buyers  of  the  things  sold,"  are  useless  as  a  definition  of 
"reasonable"    prices.     (Name    some    object    which    has    a    price 
greater  than   that   one   which   would   express  the   value   of  the 
object  to  buyers.) 

(b)  In  the  case  of  producible  goods,  what  price  is  commonly 
considered  a  reasonable  one? 

(c)  When  "reasonable"  is  understood  this  way,  is  it  probable 
that  the  first  half  of  Stickney's  statement  is  true? 

(d)  Point  out  some  cases  of  monopoly  of  which  the  state- 
ment can  be  affirmed  with  a  fair  degree  of  accuracy. 

6.  The    utilities    of    a    bushel    of    wheat    vary   by    one-cent 
difference?,  the  costs  by  5-cent  differences    (being  25c,  30c,  35c, 
etc.).     When  marginal  utility  has  reached  35c  or  more  but  not 
40c,    what   prices   may   prevail  ?     What   determines    price    under 
these  conditions  ? 

7.  "Analogous  arguments,  *  *  *  might  be  made  with  regard 
to  municipal  railways,  lighting  companies,  and  water  companies. 

269 


PRINCIPLES  OF  ECONOMICS 

These  are  all,  for  one  "ause  or  another,  of  a  monopolistic  char- 
acter. The  public  enjoys  no  guarantee  of  fair  treatment  on 
account  of  any  competition  that  can  affect  them."  Adams' 
Finance,  p.  264. 

What  is  the  doctrine  with  respect   to  competitive   industries 
which  is  implied  in  the  last  sentence  of  the  quotation? 

8.  "When  the  demand  for  wheat  increases  so  as  to  exceed 
the  capacity  of  the  best  land,  the  price  of  wheat  rises  so  as  to 
leave  an  excess  or  surplus  over  cost  of  production,  and  this  sur- 
plus is  driven  into  the  hands  of  the  landowner  as  rent  by  the 
natural    competition    of    tenants.       But,    now,   the   high   price   of 
wheat  leads  to  the  cultivation  of  inferior  soils,  which  increases 
the  supply  of  wheat  so  as  to  satisfy  the  demand,  and  thus  brings 
the  price  of  wheat  back  to  its  old  place."     Criticise  the  part  in 
italics. 

9.  "Alone  and  lost  in  the  desert,  his  last  morsel  of  food  and 
his  last  drop  of  water  gone,  he  would  cheerfully  have  given  his 
gold,  his  yachts,  his  palaces,  all  his  wealth,  for  the  meager  fare 
of  the  day  laborer.      At  last  the  illusions  which  he  shared  with 
civilized  society  were  fully  dispelled.      The  unutterable  folly  of 
the  comparative   estimates  which  men   commonly  put   on  things 
became    manifest.      At   last,   on   the   verge   of   oblivion,    he   saw 
things  in  their  true,  their  real,  proportions."      Criticise. 

10.  A   certain   man    improves   the    opportunity   offered   by   a 
growing  city  of  40,000  inhabitants  to  develop  a  messenger  service 

business,  from  which  at  the  end  of  three  years  he  finds  himself 
getting  a  net  return,  after  allowing  himself  wages  for  manage- 
ment, of  $700.  The  capital  invested,  which  includes  a  bank 
balance  of  $200  which  he  commonly  maintains,  is  only  $500;  but 
he  has  to  provide  for  a  pay  roll  of  about  $200  a  month  or  $2,400 
a  year.  He  now  tries  to  sell  out  the  business,  asking  for  it 
$8,750.  Assuming  that  the  good  will  of  the  business  is  worth 
$500,  and  that  8  per  cent  is  a  reasonable  rate  of  interest  and 
profit,  is  the  price  proposed  a  reasonable  one?  Does  the  size  of 
the  pay  roll  make  any  difference?  Explain. 

11.  A  railway  lawyer  is  trying  to  prove  before  a  court  that 
a  proposed  2  cents  per  mile  passenger  rate  is  unjust  to  his  road 
in  that  it  will  not  permit  paying  a   reasonable  profit,  say  6  per 
cent,  on  the  investment.    He  admits  that  this  rate  will  be  realized 
on  the  physical  equipment  of  the  road,  valued  at  $5,000,000 ;  but 
argues  that  the  company  has  to  provide  for  a  pay  roll  of  $50,000 
every  month  and  ought  to  earn  profits  on  this  as  well.      Now 
this    claim    may    or   may    not    be    reasonable.       It   all    turns    on 
whether   providing  for  this   pay   roll   involves,   etc.      Finish   the 
sentence. 

12.  The  table  given  below  contains  a  section  from  a  hypo- 
thetical demand  schedule  for  a  certain  producible  commodity  and 
the  corresponding  sections  from  four  different  output  schedules. 
What  prices  might  be.  fixed  under  each  of  the  output  schedules? 
Give  the  argument  in  each  case. 

270 


CHAPTER  IX.     NORMAL   PRICE 

OUTPUT  UTILITY        DEMAND 

(or)  COST 

SCH.  A  SCH.  B  SCH.  C  SCH.  D 

15                15  15  15  $52  9 

12                12  15  15  51  9 

12                12  15  15  50  12 

12                12  12  12  49  12 

12                12  12  12  48  12 

12                12  12  12  47  12 

12                12  12  12  46  12 

9                12  9  12                .45  12 

9                12  9  12  44  15 

9                12  9  12  43  15 

9999  42  15 

9999  41  15 

13.  "A  friend  of  mine  owns  in  a  Chicago  suburb  a  house  and 
lot  which  used  to  rent  for  $300  a  year.     Last  year  real  estate  in 
his  neighborhood  had  a  boom,  with  the  result  that  his  property 
increased  in  value  $3,000.     In  consequence  he  raised  the  rent  to 
$480."     What  is  the  matter  with  the  economic  doctrine  involved? 

14.  "There  is  a  good  deal  of  nonsense  said  about  the  power 
to   rob    the   public   possessed   by   a   company    which    furnishes   a 
public  utility.     The  company  can  get  no  more  than  the  public  is 
willing  to  pay.      If  the  public  think  the  price  too  high,  they  will 
not  pay  it;  and  the  company  will  be  forced  to  put  the  price  at 
what  the  public  is  convinced  is  a  fair  price." 

(a)  What   is   a   fair   price   as   generally  understood   by   the 
public  ? 

(b)  Is  there  good  reason  to  expect  that  the  companies  who 
furnish  public    utilities    will    sell    them    for    fair    prices,    in    the 
absence  of  special  contract  or  government  control?     Why? 


CHAPTER  X. 

THE  FINAL  THEORY  OF  PRICE-DETERMINATION 
SUPPLEMENTAL  TOPICS. 

In  Chapters  8  and  9,  we  have  set  forth  the  principles  gov- 
erning the  immediate  and  intermediate  processes  of  price-de- 
termination. Of  the  present  chapter,  the  first  and  larger  part 
will  be  devoted  to  our  final  task  with  respectt  to  price,  namely, 
the  explanation  of  the  final  processes  under  which  prices  are 
determined.  The  latter  portion  of  the  chapter  will  be  used  to 
clear  up  one  or  two  other  topics  connected  with  this  subject  of 
price  or  value. 

Section    A.     The    Final    Theory    of    Price-Determination. 

i.     The  Problem  Stated. 

More  than  once  in  previous  connections,  we  have  alluded 
to  the  need  for  a  final  theory  of  prices- — a  theory  which  should 
undertake  to  explain  the  ultimate  processes  by  which  prices 
are  determined.  Up  to  this  point,  'however,  we  have  evaded  the 
responsibility  of  explaining  how  any  such  need  arises.  We  can 
do  so  no  longer.  Accordingly,  we  will  now  undertake  this  task. 

Throughout  most  of  our  discussions  of  the  normal  price  of 
producible  commodities,  it  was  assumed  without  comment  that 
the  prices  of  those  constituents  of  cost  for  which  the  entrepre- 
neur has  to  make  a  money  outlay  are  quantities  which  he 
finds  determined  once  for  all.  Starting  out  to  manufacture 
some  commodity,  he  learns  that  he  must  pay  so  much  for  raw 
materials,  so  much  for  tools  and  machinery,  so  much  for  labor, 
so  much  for  the  use  of  capital,  and  so  on.  In  consequence  of 
tfiese  facts,  together  with  the  fact  that  he  has  to  make  certain 
sacrifices  peculiar  to  himself,  the  product  which  he  puts  on  the 
market  has  to  have  a  certain  price.  This  way  of  conceiving 
the  matter  may  be  expressed  graphically  by  the  diagram  ap- 
pearing in  Figure  i.  In  the  left  hand  column  are  cost  goods, 
that  is,  the  materials,  labor,  etc.,  from  which  or  through  which 
products  are  made.  In  the  right  hand  column,  are  the  products 

272 


CHAPTER  X.    FINAL  PRICE  DETERMINATION 


made  from  these  cost  goods.     Between  them  runs  from  left  to 
right    the    arrow,    'Trice-Determination/'     signifying    that    the 


Cost  Goods 


Products 


Earth   " 
Tools 
Lumber 
Labor 
Ores 
Powers 
Wheat 
Machines 
Waiting 
Iron 
etc 
etc 

Price 

Houses 
Furniture 
Food 
Clothes 
Books 
Pictures 
Flowers 
etc 
etc 
etc 
etc 
etc 

Determi- 
nation 

Fig.  i. 

prices  of  the  cost  goods  zvhicJi  were  fixed  in  advance  are  now 
determining  the  prices  of  their  products. 

But  we  hardly  need  say  that  the  above  assumption  with 
respect  to  the  prices  of  cost  goods,  namely,  that  said  prices  are 
quantities  fixed  in  advance,  though  sufficiently  true  for  many 
purposes,  is  plainly  untrue  as  a  statement  of  the  ultimate  facts. 
Some  constituents  of  cost  are  themselves  products,  and  so, 
plainly,  their  prices  cannot  be  fixed  in  advance,  but  rather  must 
be  in  process  of  determination  under  the  same  cost  principles 
which  are  determining  the  prices  oi  final  or  consumers'  pro- 


Priinary  Cost  Goods 


Produced  Cost  Goods  or 
Intermediate  Products 


Final  Products 


Earth  " 
Powers 
Ores 
Labor 
Waiting 
etc 
etc 
etc-> 

"    Lumber 
Iron 
Tools 
Machines 
Copper 
etc 
etc 
etc 

>*to 

r  Houses 
Furniture 
Food 
Clothes 
Books 
etc 
etc 
etc 

Fig.  2. 

ducts.  Changing  our  diagram  so  as  to  recognize  this  new 
phase  of  the  istuation,  it  now  takes  on  the  form  shown  in 
Figure  2.  Here  we  have  three  columns.  Of  these,  the  first 

273 


PRINCIPLES  OF  ECONOMICS 

contains  what  we  will  call  the  primary  cost  goods,  that  is,  fac- 
tors in  production  which  cannot  be  resolved  into  anything  more 
primary,  e.g.,  the  soil,  ores  in  the  earth,  'water-power,  human 
labor,  and  so  on.  The  second  contains  the  produced  cost  goods 
or  intermediate  products,  such  as  lumber,  wheat,  flour,  cloth, 
and  so  on.  The  third  contains  final  products,  products  in  final 
form  for  the  satisfying  of  wants.  As  before,  the  arrows  run- 
ning from  left  to  right  indicate  what  would  be  the  general 
course  of  causation, — provided  a  pure  money  cost  theory  of  prices 
were  an  adequate  account  of  the  matter.  That  is,  in  our  diagram, 
the  prices  of  the  primary  cost  goods  are  represented  as  ante- 
cedently fixed;  being  thus  fixed,  they  determine  the  prices  of 
intermediate  products  or  produced  cost  goods;  when,  finally, 
the  prices  of  these  latter  determine  the  prices  of  consumers' 
products. 

But,  again,  it  is  hardly  necessary  to  say  that  we  are  really  no 
better  off  than  before.  We  have,  indeed,  got  rid  of  the  absurdity 
of  representing  the  prices  of  produced  cost  goods  as  antecedently 
fixed;  but  we  still  assume  that  the  prices  of  primary  cost  goods 
are  antecedently  fixed,  and  this  assumption  is  little  less  absurd 
than  the  former.  Iron  ore  stored  up  in  the  earth,  a  favorable 
site  for  business,  the  soil  itself,  a  day's  kbor,  none  of  these  has 
a  particular  price  attaching  to  it  from  eternity.  The  price  of 
every  one  of  them  is  constantly  being  changed.  Most  of  all,  the 
prices  of  these  primary  cost  goods  are  surely  being  influenced 
more  or  less  by  those  very  pirces  which  they  are  represented  as 
determining.  For  it  is  quite  obvious  that,  if  final  products  did 
not  have  prices,  intermediate  ones  would  not  have  any ;  and  that, 
if  these  intermediate  as  well  as  the  final  products  did  not  have 
prices,  primary  cost  goods  would  not  have  any.  That  is,  it  would 
seem  that  our  diagram  should  have  'been  made  with  the  arrows 
running  from  right  to  left,  as  in  Figure  3,  rather  than  from 
left  to  right. 

But,  now,  we  seem  to  be  up  against  a  complete  contradiction. 
Only  a  few  pages  back,  we  were  saying  that,  in  many  cases 
anyhow,  the  money  value  of  the  cost  goods  contained  in  any 
particular  product  determines  the  price  of  that  product.  Now, 
we  seem  to  be  saying  that  the  prices  of  products  determine  the 
prices  of  cost  goods.  Have  we  here  two  irreconcilable  doctrines? 
Shall  we  have  to  give  up  entirely  one  or  the  other  of  these  con- 
tentions? By  no  means.  It  is  entirely  possible,  in  fact  quite  cer- 

274 


CHAPTER  X.    FINAL  PRICE  DETERMINATION. 

tain,  that  causation  is  moving  in  both  directions.  Two  sets  of 
forces  are  bound  to  have  a  share  in  determining  price,  one  start- 
ing from  the  supply  side,  one  from  the  demand  side.  At  some 


Primary  Cost  Goods 


Produced  Cost  Goods  or 
Intermediate  Products 


Final  Products 


Earth  - 
Powers 
Ores 
Labor 

1      < 

"    Lumber 
Iron 
Tools 
(Machines 

"  Houses 
Furniture 
Food 
Clothes 

Waiting 
etc 

etc 
etc^ 

' 

Copper 
etc 
etc 
etc 

Books 
etc 
etc 
I  etc 

Fig.  3- 

points,  the  forces  from  the  supply  side  will  for  the  moment  con- 
stitute the  decisive  factor.  At  other  points,  those  from  the  de- 
mand side  will  hold  this  place.  But  the  final  resultant,  when 
equilibrium  has  been  established,  will  be  one  in  the  determination 
of  which  forces  from  both  sides  have  participated  and  this 
brings  us  to  see  that  our  problem  has  really  taken  on  a  different 
form  from  what  it  seemed  to  have  at  the  outset.  Then  we 
thought  of  our  present  problem  as  being  the  completion  of  the 
task  already  -started.  That  is,  we  had  studied  the  prices  of 
products,  we  were  now  to  finish  our  work  by  studying  the  prices 
of  the  primary  cost  goods  entering  into  these  products.  But 
from  our  new  point  of  view,  it  has  become  plain  that  our  present 
problem  is  not  a  new  problem  at  all,  but  rather  our  old  problem 
studied  in  a  deeper  way.  We  are  still  trying  to  find  o'ut  how  the 
prices  of  products  are  determined,  only  we  are  now  looking  for 
the  really  ultimate  solution  instead  of  the  merely  provisional  ones 
with  which  we  have  thus  far  contented  ourselves. 

2.    First  Approximation. 

Hypothesis : — One  Primary  Cost  Good,  No  Disutility  Cost,  Sup- 
ply or  Output  of  Primary  Cost  Good  Fixed. 
In   order  to   make   our  task  reasonably  easy,    we   will   start 
with  a  hypothesis  of  highly  artificial  simplicity  and  by  successive 
modifications  bring  it  into  something  like  correspondence   with 
the    real   world.      In   this    opening   hypothesis,    we    will    suppose 
(i)  that  there  is  but  one  primary  cost  good,  call  it  L;    (2)  that 
there  is  just  so  much  of  this  primary  cost  good  available,  no  more 

275 


PRINCIPLES   OF   ECONOMICS 

and  no  less;  (3)  that  no  disutility,  no  sacrifice,  on  our  part  is 
involved  in  producing  or  employing  this  cost  good;  (4)  that  our 
stock  or  output  of  this  primary  cost  good  is  devoted  to  produc- 
ing directly  six  products,  Pi,  P2,  P3,  and  so  on;  (5)  that  these 
products  have  marginal  utilities  of  $120,  $80,  $48,  $24,  $12,  and  $4, 
respectively ;  and  (6)  that  these  products  contain,  respectively,  12 
units,  10  units,  8  units,  6  units,  4  units,  and  2  units  of  our  original 
cost  good  L. 

Let  us  ask,  now :  What,  under  the  conditions  given,  would 
tend  to  be  the  prices  of  Pi,  P-N  P3,  etc.  and  the  price  of  Ls,  and 
what  would  be  the  course  of  causation  in  the  determining  of  these 
prices?  Putting  into  tabular  form  those  data  from  the  above 
hypothesis  which  are  most  essential  to  the  answering  of  these 
questions,  we  have  the  table  below.  (M  S  stand  for  marginal 
significance.)  Here  the  course  of  technical  causation,  production, 

i2Ls  produce  iPi  having  M  S  $120 
loLs  produce  iP2  having  M  S  $  80 
8Ls  produce  iP3  having  M  S  $  48 
6Ls  produce  iP^  having  MS  $  24 
4Ls  produce  iP.-,  having  M  S  $  12 
2Ls  produce  iP0  having  M  S  $  4 

is  from  left  to  right,  from  Ls  to  Ps.  But  what  about  price  caus- 
ation? Since  we  have  the  first  appearance  of  a  money  expression 
in  the  third  column,  the  marginal  significance  column,  and  since 
the  marginal  significance  of  things  is  surely  a  necessary  ground 
for  the  existence  of  price,  our  first  thought  might  naturally  be 
that  price-causation  begins  here.  That  is,  the  marginal  signifi- 
cance of  any  one  of  these  products  would  first  be  determined  and 
expres'sed  in  terms  of  money;  this  money  expression  of  the 
marginal  significance  of  the  product  would  then  determine  the 
price  of  that  product;  when,  finally,  the  price  of  said  product 
would  determine  the  price  of  the  Ls  entering  into  it.  In  fact, 
not  a  few  writers  have  at  times  seemed  to  say  something  very 
much  like  this  in  respect  to  the  determination  of  prices  under  the 
present  order.  Supposing,  for  a  moment,  that  such  a  theory  were 
sound,  the  course  of  price-determination  would,  in  that  case,  be 
as  shown  in  Figure  4.  Here  we  have  six  independent  lines  of 
causation  all  running  from  right  to  left,  each  beginning  with  the 
marginal  significance  f  the  product,  going  from  this  to  deter- 
mine the  price  of  that  product,  then  from  this  to  determine  the 
money  value  of  the  Ls  entering  into  said  product,  and,  finally,. 

27G 


CHAPTER  X.    FINAL  PRICE  DETERMINATION. 

from  this  to  determine  the  price  of  a  single  L,  as  appearing  in 
that  product. 

But,  now,  it  hardly  seems  necessary  to  say  that  such  a  course 
of  price-determination   as  the  one  brought  out   in  the  diagram, 


Fig.  4- 

would  be  quite  impossible;  for,  if  it  prevailed  we  should  have 
six  different  prices,  $10,  $8,  $6,  $4,  $3,  and  $2,  for  the  same  com- 
modity, one  L,  in  the  same  market,  at  the  same  time, — a  condition 
of  things  which,of  course,  is  quite  out  of  the  question.  Ls  can  have 
but  one  price  in  the  same  market  at  the  same  time ;  and  that  price 
must  be  the  lowest  of  the  six  enumerated,  that  is,  $2 ;  for,  other- 
wise, Ls  could  not  be  put  to  this  lowest  use  to  which  by  'hypothesis 
they  are  put.  But,  if  the  man  who  was  producing  P5  had  to  pay 
for  the  Ls  used  in  this  product  only  $2  each  and  needed  for  each 
P5  only  four  of  these  Ls,  he  surely  would  not  'be  able  to  get  for 
said  Pss  $12  each,— instead,  $8  would  be  the  limit.  That  is,  the 
uniform  price  of  'P5s  on  the  market  would  have  to  be  $8  each. 
Similarly,  P^,  which  contains  six  Ls  could1  not  have  a  price  of 
$24,  but  only  one  of  six  times  $2,  or  $12.  So,  P3,  which  contains 
8  Ls  could  not  have  a  price  of  $48,  but  only  one  of  eight  times 
$2,  or  $16.  P2  could  not  have  a  price  of  $80,  but  only  one  of  ten 
times  $2,  or  $20.  Finally,  Pi  could  not  have  a  price  of  $120,  but 
only  one  of  twelve  times  $2,  or  $24.  That  is,  the  course  of  price- 
determination  for  all  of  these  products  except  P6  would  have  to 
be  from  cost  of  production  towards  the  price  of  the  product, 
rather  than  from  the  marginal  significance  or  utility  of  the 
product  to  its  price,  then  to  the  price  of  its  cost  good,  and  so  on. 
This  method  of  explaining  the  process  of  price-determination  is 
represented  in  Figure  5. 

At  the  top  of  this  diagram,  it  is  indicated  that  the  primary 

277 


PRINCIPLES  OF  ECONOMICS 

factors  in  price-determination,  in  the  case  under  consideration, 
are  the  stock  of  Ls  and  the  significance  schedules  of  the  several 
products,  Pi,  P2,  etc.  These  are,  so  to  speak,  the  springs  from 


Co 

I      / 

i  L?zbo  «  — 

T    Goods 

Price  of 
Products 

MarqS.gn.f,- 
Canc*  of  Products 

.IP,'* 

MST; 

MSP, 
MSP5 

'    d§p, 

_joujT| 

'w. 

<^80. 

^24. 
4  12. 
^4. 

- 

•  •  'l  P  •*  1  6 

6L.'l2  

?  L.a*4 

>   |  P4  *  »2. 

—  .  iV,  'a 

|   p     4  A          . 

Fig.B 

which  flow  all  the  forces  which  in  any  way  are  concerned  in 
price-determination.  The  arrows  leaving  these  starting  points, 
going  around  the  main  part  of  the  diagram,  and  meeting  at  the 
lower  right  hand  corner  bring  out  the  point  that,  however  com- 
plicated the  processes  by  which  the  result  would  be  reached, 
under  our  present  hypothesis-,  the  price-determining  forces  would 
come  to  a  focus  in  the  marginal  significance  of  the  marginal 
product.  The  spur  arrows  which  leave  the  main  arrows  on  the 
several  levels  of  the  supra-marginal  products  signify  that,  after 
all,  causation  is  setting  in  at  other  points  also.  The  remainder  of 
the  diagram  shows  that,  after  equilibrium  has  been  reached,  the 
reaction  which  is  logically  first  among  the  reactions  set  up  by  the 
interaction  of  the  stock  of  Ls  and  the  several  significance  sched- 
ules is  the  fixing  of  the  marginal  significance  of  the  marginal 
product,  P6.  That,  being  finally  fixed  at  $4,  would  cause  the  price 
of  Po  to  be  $4,  as  indicated  by  the  arrow  going  from  right  to 
left  between  these  points.  This  price  of  $4  for  PC.  would,  in  turn, 
make  the  money  value  of  the  2  Ls  contained  in  it  $4,  and,  so, 
would  make  the  price  of  one  L  $2.  This  price  of  $2  each  for  the 
marginal  Ls  would  now  be  communicated  to  all  other  Ls,  namely, 
to  those  Ls  which  are  used  in  the  higher  products.  In  conse- 
quence, the  money  value  of  that  quantity  of  Ls  which  is  used  in 
each  of  the  several  products  would  remain  as  many  times  $2  as 

278 


CHAPTER  X.    FINAL  PRICE  DETERMINATION. 

the  number  of  Ls  used  in  producing  said  product.  Finally,  the 
money  value  thus  established  for  the  Ls  contained  in  each  pro- 
duct would  be  communicated  to  the  products  themselves ;  that  is, 
to  P5,  ?4,  P;;,  PL-,  and  Pi,  as  indicated  by  the  five  horizontal  arrows 
running  from  left  to  right.  Th'e  disappearance  of  the  arrows 
which  in  the  former  diagram  ran  between  the  marginal  signifi- 
cance of  P!  and  its  price,  between  the  marginal  significance  of 
P2  and  its  price,  between  the  marginal  significance  of  P3  and  its 
price,  and  so  on,  signifies  that,  for  these  supra-marginal  cases, 
the  connection  between  the  marginal  significance  of  those  prod- 
ucts and  their  prices  would,  according  to  our  amended  theory, 
be  completely  broken. 

Caution :  In  seeking  to  make  clear  the  theory  of  price-deter- 
mination just  explained,  it  is  almost  impossible  to  avoid  the  coming- 
in  of  misleading  implications.  That  is,  it  is  almost  impossible  to 
avoid  giving  the  impression  that  the  marginal  utility  of  P6  would 
be'  first  determined  independently  of  everything  else;  that  this 
marginal  utility  would  thereupon  determine  the  price  of  P8  in- 
dependently of  everything  else;  that  the  price  of  P6  thus  deter- 
mined would  then  fix  the  price  of  Ls  devoted  to  its  production 
independently  of  everything  else;  and  so  on.  Now,  it  is  surely 
quite  impossible  that  anything  like  this  should  take  place.  No 
one  of  these  things,  whether  the  marginal  utility  of  the  marginal 
product  or  the  price  of  any  one  of  the  various  products  or  the 
price  of  Ls,  could  be  determined  independently  of  the  determina- 
tion of  every  other  one  of  them.  The  marginal  significance  of  P6 
could  not  be  determined  until  the  output  of  this  product  had  been 
finally  determined.  In  turn,  the  output  of  -P6  could  not  be  de- 
termined until  the  question  of  the  number  of  Ls  available  for  this 
purpose  had  been  determined.  Againi,  the  question  of  the  Ls 
available  for  producing  P,-,s  could  not  be  determined  until  it  had 
been  decided  how  many  of  the  higher  products,  Pi,  P2,  Ps;  P4, 
were  to  be  produced.  Still,  again,  it  could  not  finally  be  deter- 
mined how  many  of  these  higher  products  were  to  be  produced 
until  it  was  known  what  price  they  were  to  have  and,  therefore, 
what  demand  there  would  be  for  them.  But  since  their  price 
would  be  dependent  on  the  price  of  the  Ls  entering  into  them, 
and  the  price  of  Ls  would  be  dependent  on  the  price  of  P6,  and 
the  price  of  P«  would  be  dependent  on  its  marginal  utility,  we 
seem  to  be  in  a  position  where  we  are  obliged  to  say  that  nothing 
could  be  determined  until  everything  else  had  been  determined. 
That  is,  we  seem  to  be  trying  to  break  into  a  completely  closed 
circle.  And  this  is  of  course  true.  Nothing  could  be  finally  de- 
termined until  even-thing  else  had  been  determined.  As  in  so 
many  other  fields,  reaction  as  well  as  action  is  present  and  the 
result  must  be  influenced  by  both.  Nevertheless,  it  is  legitimate 
to  represent  the  real  order  of  causation,  when  everything  is  finally 
settled,  in  the  way  we  have  done.  When  at  last  equilibrium  would 

279 


PRINCIPLES  OF  ECONOMICS 

have  been  reached,  the  starting  point  of  this  causation — the  point 
where  the  fundamental  price-determining  forces  break  into  the 
circle — would  be  in  the  marginal  significance  of  the  product. 

The  discussion  of  the  preceding  paragraph  suggests  another 
point  with  respect  to  the  case  before  us  which  is  of  very  great 
importance,  namely,  the  point  that  the  prices  of  the  marginal 
products,  of  the  cost  good  L,,  and  of  the  various  supra-marginal 
products  necessarily  constitute  a  coherent,  consistent,  system  of 
inter-dependent  prices.  No  one  of  them  is  determined  by  itself. 
They  are  all  determined  as  a  part  of  one  complicated  system  of 
price-determination.  The  doctrine,  seemingly  entertained  by 
some,  that  the  price  of  an  individual  product  can  be  determined 
by  its  own  marginal  utility  independently  of  other  things  is  quite 
untenable.  On  the  other  hand,  the  doctrine,  seemingly  enter- 
tained by  some,  that  the  prices  of  particular  products  can  be 
finally  determined  by  their  costs  of  production,  independently  of 
everything  else,  is  quite  untenable.  We  cannot  too  often  repeat 
that  the  price  of  none  of  the  things  we  are  dealing  with  can  be 
determined  finally  until  the  price  of  every  one  is  determined 
finally. 

We  are  not  yet  ready  to  leave  our  original  hypothesis;  but  I 
wish  to  make  a  very  slight  change  in  it,  by  supposing  that  Ls, 
instead  of  being  used  diretly  in  the  production  of  Pi,  P2,  P3,  etc., 
are  first  employed  in  making  intermediate  products,  from  which, 
in  turn,  come  the  final  products,  Pi,  P2,  Ps,  and  so  on.  For  ex- 
ample, let  us  suppose  that  Ls  are  used  to  produce  wheat ;  that 
from  this  wheat  flour  is  made ;  and  that  from  the  flour,  bread, 
the  final  consumers'  product,  is  made.  Will  this  introduction  of 
a  new  link  in  the  process  materially  alter  the  result?  We  can 
hardly  doubt  that  the  correct  answer  will  be  a  negative  one.  The 
processes  whereby  equilibrium  would  be  finally  fixed  would  un- 
doubtedly be  much  more  complicated  than  in  the  original  hypo- 
thesis, and  we  should  find  almost  insuperable  difficulties  in  at- 
tempting to  illustrate  these  processes  by  a  graphic  diagram.  But 
few  persons,  if  any.  would  doubt  that  results  substantially  similar 
to  those  of  the  preceding  case  would  finally  be  reached.  When 
equilibrium  had  been  fully  established,  the  price  of  one  L  would 
express  the  marginal  utility  of  the  marginal  consumers'  product 
dependent  upon  it;  the  prices  of  marginal  products  would  express 
their  marginal  significances;  the  prices  of  supra-marginal  pro- 
ducts, whether  final  products  or  intermediate  ones,  would  be 

280 


CHAPTER   X.     FINAL  PRICE  DETERMINATION. 

equal  to  the  money  value  of  the  Ls  contained  in  them;  and  this 
price  of  Ls  and  these  prices  of  products  would  all  tend  to  con- 
stitute a  coherent,  consistent,  system  of  interdependent  prices. 
As  this  simple  case  supplies  the  principle  which  in  more  elab- 
orate and  qualified  form  will  appear  in  our  final  formula,  I  will 
present  it  here  in  what  we  will  designate  as  Formula  A. 

Formula  A.  //  there  were  but  one  primary  cost  good  and  that 
one  were  strictly  limited  in  amount  or  output  and  had  no  dis- 
utility cost,  complete  equilibrium  among  the  price-making  forces 
•would  be  reached  when,  and  only  when,  there  had  been  established 
a  coherent  system  of  interdependent  prices  such  that  (i)  the 
prices  of  marginal  products  expressed  their  marginal  significance; 
(2)  the  price  of  the  primary  cost  good  expressed  the  significance 
of  that  primary  cost  good  in  its  marginal  product  and  that  only; 
and  (3)  the  prices  of  the  supra-marginal  products  were  equal 
to  the  money  value  of  the  primary  cost  goods  entering  into 
them. 

3.     Second  Approximation. 

Hypothesis : — One  Primary  Cost  Good,  A  Disutility  Cost,  Supply 

or  Output  Variable. 

We  have  worked  out  a  formula  for  the  final  determination  of 
prices,  including  the  prices  of  products  both  intermediate  and 
final,  and  that  of  the  primary  cost  good,  on  the  simple  'hypothesis 
that  there  is  but  one  primary  cost  good,  that  the  stock  output  of 
that  cost  good  is  absolutely  fixed,  and  that  it  has  no  disutility 
cost.  The  clearing  up  of  this  case  was  almost  indispensable  as  a 
means  for  making  the  formula  which  applies  to  the  more  complex- 
conditions  of  real  life,  even  intelligible;  but  I  hardly  need  remark 
that  this  hypothetical  case  which  we  have  been  studying  is  very 
far  indeed  from  representing  the  facts  of  life.  Let  us  now  bring 
our  hypothesis  a  step  nearer  to  those  facts  by  supposing  that  Ls, 
instead  of  existing  in  a  fixed  amount,  or  coming  forth  each  year 
in  a  fixed  output,  come  into  existence  through  human  choice  and 
that  their  production  involves  a  disutility  cost  which  increases  di- 
rectly as  the  quantity.  Will  this  new  element  of  real  cost 
modify  the  ultimate  laws  which  regulate  the  value  of  products? 
The  answer  depends  on  what  choice  we  make  among  three  pos- 
sible subordinate  modifications  of  our  hypothesis.  We  may  sup- 
pose (1)  that  our  wants  are  so  numerous  and  our  capacities  so 

281 


PRINCIPLES  OF  ECONOMICS 

small  that  our  marginal  efforts  make  no  appreciable  addition  to 
output  and,  so,  do  not  affect  marginal  utility  or  value, — we  are 
all  in  the  position  of  producers  in  our  "tea  problem";  or  (2) 
that  our  wants  are  so  few  and  our  capacities  so  great  that  we 
are  able  to  satisfy  absolutely  all  our  wants  without  being  oblig- 
ed anywhere  to  push  our  productive  efforts  beyond  the  point 
of  maximum  efficiency;  or  (3)  that  the  facts  lie  'between  these 
extremes. — our  capacities  and  wants  are  so  far  matched  that  the 
disutility  involved  in  production  and  the  significances  resulting 
therefrom  vary  with  changes  in  the  volume  of  output  at  some- 
thing like  the  same  rate,  though  in  opposite  directions.  Now, 
whether  or  not  disutility  would  play  a  part  in  price-determination 
under  the  'simple  economic  order  with  which  we  started  would 
depend  on  which  of  these  three  alternative  conditions  was  char- 
acteristic of  that  order;  for,  under  two  of  these,  disutility  would 
have  a  share  in  determining  price,  while,  under  the  other,  it  would 
not  have  such  a  share.  Let  us,  first,  make  this  point  clear. 

If  we  start  with  the  first  of  the  above  alternatives, — that,  on 
account  of  the  greatness  of  our  wants  and  the  smallness  of  our 
capacities,  our  marginal  efforts  make  no  appreciable  additions  to 
output, — it  is  quite  certain  that  disutility  would  be  shut  out  as  a 
price-determinant ;  for,  in  that  case,  all  commodities  would  be  in 
the  position  of  the  rare  brand  of  tea  which  figured  in  Section  B 
of  Chapter  9.  That  is,  all  goods  would  be,  in  effect,  fixed-supply 
good's.  For,  by  hypothesis,  production  would  always  be  carried 
so  far  that  the  additions  to  output  resulting  from  additional 
sacrifices,  though  worth  obtaining,  would  not  be  great  enough 
appreciably  to  affect  supply  and  so  not  great  enough  to  affect 
price.  In  this  case,  therefore,  the  solution  of  our  problem  already 
set  forth  in  Formula  A  would  be  sufficient.  Disutility  would  play 
no  part  in  price-determination.  Significance  or  utility  alone 
would  do  the  work. 

Let  us  turn,  now,  to  the  second  of  three  alternatives  with 
respect  to  the  relation  between  capacities  and  wants.  Supposing 
that  our  capacities  were  so  great  and  our  wants  so  few  that 
we  were  able  to  satisfy  all  those  wants  without  anywhere  push- 
ing production  beyond  the  point  of  maximum  efficiency,  would 
the  final  determinant  of  prices  be  significance,  as  before,  or 
disutility  or  both  of  these  com'bined?  We  answer  that  it  would 
be  disutility  alone.  The  proof  is  easy.  The  essential  feature  of 
our  latest  hypothesis  is  that  we  should  be  able  to  satisfy  every 

232 


CHAPTER  X.    FINAL  PRICE  DETERMINATION. 

want  without  pushing  production  beyond  the  point  of  maximum 
efficiency, — a  condition  which  means  that  an  indefinitely  large 
output  could  be  supplied  at  the  lowest  cost  possible  under  a 
given  development  of  technique.  But  this  being  true,  all  supply 
schedules  would  necessarily  be  of  the  one-price  class ;  and  the 
one  supply  price  would  necessarily  express  the  disutility  of  pro- 
duction. This  would  surely  follow  from  the  conditions  involved. 
Price  could  not  be  above  this  point;  for  the  amount  which  could 
be  produced  at  this  figure  would  always  be  in  excess  of  demand, 
and  hence  the  competition  of  sellers  would  promptly  eliminate 
any  higher  price.  On  the  other  hand,  price  could  not  go  below 
this  point;  for,  the  sacrifice  involved  in  production  not  being 
covered,  if  price  went  any  lower,  supply  would  disappear  alto- 
gether*, and,  therefore,  buyers  would  be  driven  to  bring  price 
up  to  this  point.  Thus,  under  the  third  form  of  our  'hypothesis, 
the  supply  schedules  of  all  goods  would  be  one-price  schedules, 
actual  price  would  therefore  have  to  coincide  with  this  one 
price,  and,  so,  would  have  to  express  disutility.  But,  this  being 
true,  actual  price  would  obviously  be  unable  to  follow  marginal 
significance  also;  and  hence,  in  this  case,  disutility  alone  would 
determine  price.  Manifestly,  these  prices  could  never  be  greater 
than  the  significance  or  utility  of  the  commodity  involved;  but 
they  might  easily  be  less.  If  significances  and  prices  did  coin- 
cide, this  would  be  true  becaues  the  former  had  adjusted  them- 
selves to  the  latter.  Accordingly,  if  we  try  to  set  forth  a  com- 
plete formula  for  prices  under  this  hypothesis,  we  shall  have  one 
something  like  the  following: 

Formula  B.  //  there  were  but  one  primary  cost  good  and  I 
the  supplying  of  that  cost  good  involved  a  disutility,  while,  how- 
ever, our  capacity  to  supply  that  cost  good  was  greatly  in  excess 
of  our  need,  complete  equilibrium  among  the  price-making  forces 
would  be  reached  when,  and  only  when,  there  had  been  estab- 
lished a  coherent  system  of  interdependent  prices  such  that  the 
price  of  any  particular  product  equalled  the  money  value  of  the 
primary  cost  good  entering  into  said  product,  while  the  price  of 


*  It  is  just  conceivable  that  the  supply  of  the  primary  cost  good 
would  be  furnished  in  more  than  sufficient  amount,  in  spite  of  its  having 
a  disutility  cost,  through  the  influence  of  other  motives  than  the  reward 
to  be  obtained  from  its  products.  Thus,  it  might  be  conceived  that 
labor  was  the  only  primary  cost  good,  that  it  had  a  disutility  cost,  but 
that  work  was  necessary  to  a  man's  health  and,  hence,  man  would  work 
so  much  whether  any  reward  was  offered  or  not.  This,  however,  is  too 
improbable  for  serious  consideration. 

283 


PRINCIPLES  OF  ECONOMICS 

the  primary  cost  good  itself  was  such  as  to  express  the  marginal 
disutility  of  supplying  said  cost  good,  whether  it  expressed  the 
marginal  significance  of  that  cost  good  or  not. 

But  we  have  yet  to  consider  the  third  of  our  three  alterna- 
tives with  respect  to  the  relation  of  capacities  and  wants,  namely, 
that  alternative  under  which  significances  and  disutilities  would 
vary  with  changes  in  output  at  about  the  same  rate;  so  that 
with  every  increase  in  amount  we  should  have  a  considerable 
increase  in  cost  and  a  similar  decrease  in  -utility  or  significance. 
Taking  this  as  our  hypothesis,  what  would  be  the  final  determin- 
ant of  the  price  of  theultimate  cost  good,  significance?  or  disutil- 
ity? or  both?  Answer:  both.  Under  our  present  hypothesis, 
neither  marginal  significance  nor  marginal  disutility  could  pos- 
sibly be  represented  as  determining  price,  save  as  either  was 
understood  to  include  the  other.  The  argument  is  plain,  y  By 
hypothesis,  both  significance  and  disutility  vary  with  price  at 
something  like  the  same  rate;  so  that  the  changes  in  either  de- 
mand or  supply  consequent  upon  price  changes  will  necessarily 
be  sufficiently  great  to  bring  about  changes  in  actual  price.  This 
being  true,  the  price  of  Ls  could  not  be  greater  than  their  mar- 
ginal significance ;  since,  in  that  case,  demand  would  fall  off, 
leaving  a  supply  of  unused  Ls  to  find  a  market  by  coming  down 
in  price.  On  the  other  hand,  the  price  of  Ls  could  not  be  below 
their  marginal  significance;  since,  in  that  case,  extra-marginal 
uses  would  compete  for  a  supply  of  Ls,  and  the  higher  uses, 
would  be  obliged  to  raise  the  price  in  order  to  insure  their  own 
satisfaction.  The  case  of  marginal  disutility  is  equally  plain. 
If  price  were  too  low  to  express  said  marginal  disutility,  supply 
would  of  course  fall  off,  causing  price  to  rise.  If  price  were 
too  high  to  express  said  marginal  disutility,  the  Ls  which  cost 
extra-marginal  disutilities  would  come  on  the  market,  thus  mak- 
ing the  supply  of  Ls  excessive  and  so  lowering  their  price.  From 
all  this  it  follows  that  the  formula  which,  under  this  new  hy- 
pothesis, would  completely  cover  the  case  much  be  one  which 
results  from  a  blending  of  Formulas  A  and  B.  We  might  state 
it  as  follows : 

Formula  C.  //  there  were  but  one  primary  cost  good  and  the 
supplying  of  that  cost  good  involved  a  disutility,  while  our 
wants  and  capacities  were  so  related  that  the  'significance  and  the 
disutility  of  our  actual  output  "varied  at  something  like  the  same 
rate,  though  in  opposite  directions,  then  complete  equilibrium 

284 


CHAPTER  X.    FINAL  PRICE  DETERMINATION. 

among  the  price-making  forces  would  be  reached  when,  and  only 
when,  there  had  been  established  a  coherent  system  of  interde- 
pendent prices  such  that  (i)  the  prices  of  marginal  products  ex- 
pressed both  their  own  marginal  significance  and  the  disutility  of 
the  cost  good  entering  into  them;  (2)  the  price  of  the  primary 
cost  good  expressed  both  the  significance  of  its  marginal  output 
and  its  own  marginal  disutility;  and  (3)  the  prices  of  supra- 
r.iarginal  products  equalled  the  money  cost  of  the  primary  cost 
good  entering  into  them* 

In  order  to  bring  out  sharply  the  difference  between  this  case 
and  our  first  one  which  gave  us  Formula  A,  I  have  tried  to  con- 
struct a  diagram  which  would  display  graphically  the  most 
important  peculiarities  of  this  case,  as  the  diagram  in  Figure  5 
displayed  those  of  the  first  case.  Such  a  diagram  appears  in 
Figure  6.  It  is,  of  course,  quite  impossible,  in  such  a  diagram, 
to  bring  out  a  tithe  of  the  reactions  involved  in  even  this  simple 


MSP,  Vo.  - 
MSP,  'so.  - 

MSP,  '48.  - 


case  of  price-determination,  or  even  to  secure  theoretic  con- 
sistency among  those  reactions  represented;  but  this  one  will 
serve  to  clear  up  the  main  points  of  our  present  problem.  In 
the  diagram,  we  have  an  additional  column  at  the  left,  namely, 
the  marginal  disutilities  of  producing  the  different  products, — 
supposing  them  to  be  produced  in  the  order  of  their  importance. 
Since  disutility  increases  with  increasing  output,  the  figures  in 


*  The  student  will  notice  that  this  formula  is  closely  analogous  to 
the  principle  which  was  earlier  laid  down  as  governing  the  ordinary 
normal  price  of  increasing-cost  goods. 

285 


PRINCIPLES  OF  ECONOMICS 

this  column  will  get  larger  as  we  go  downward.  Another  addi- 
tional feature  in  this  diagram  is  the  reaction  between  the  dis- 
utility of  supplying  Ls  and  the  volume  of  demand  for  product. 
This  appears  in  the  lower  left-hand  corner.  As  in  the  case  of 
the  reaction  between  the  significance  of  products  and  their  out- 
put, this  set  of  reactions  between  marginal  disutility  and  the 
volume  of  demand  comes  to  a  focus  in  the  Ls  which  supply  tJit 
marginal  product  PQ.  The  double  row  of  arrows  in  the  bottom 
line  of  our  tables,  one  of  which  runs  to  the  left,  the  other  to 
the  right,  signifies  that  marginal  significance  and  marginal  dis- 
utility are  reciprocalll  determined.  The  two  arrows  going  to  one 
L,  in  the  space  between  the  first  and  second  columns  signify 
that  both  marginal  disutility  and  marginal  significance  directly 
participate  in  fixing  the  price  of  Ls. 

We  have  seen  that  there  are  three  possible  alternatives  with 
respect  to  the  relation  of  capacities  and  wants  -when  our  hypothe- 
sis is  so  modified  as  to  include  the  disutilities  of  production  as 
well  as  the  significances  of  products,  and  that  there  would 
be  a  different  formula  for  prices  in  each  of  these  cases. 
Which,  now,  of  these  three  alternatives  must  be  chosen  as 
the  one  which  most  nearly  realizes  the  conditions  of  real 
life?  While  there  is  some  difference  of  opinion,  most  econom- 
ists doubtless  would  decide  for  the  third.  The  second  surely 
must  at  once  be  eliminated.  If  we  exclude  the  half-savage  ne- 
groes of  some  tropical  region,  man  is  far  from  being  so  situ- 
ated that  he  can  easily  satisfy  all  his  wants.  The  only  question 
remaining,  the?],  is  whether  the  first  alternative  represents  actual 
life.  Are  we,  in  respect  to  goods  in  general,  in  the  position  of 
the  producers  of  the  very  rare  brand  of  tea?  The  peculiarity 
of  the  "tea  case"  is  that  wants  so  greatly  exceed  productive 
capacity  that  we  find  ourselves  almost  at  the  outset  far  down 
in  the  stage  of  diminishing  returns : — the  very  small  amount 
which  we  can  add  to  output  by  greater  expenditure  has  no  ap- 
preciable influence  on  the  size  of  the-  total  and,  therefore,  does 
not  modify  marginal  utility  or  price.  I  cannot  believe  that  this 
pictures  the  facts  of  industrial  life  in  general.  In  most  indus- 
tries, surely,  the  word  of  "the  last  hour''  has  an  appreciable  ef- 
fect on  the  volume  of  output.  If  it  were  not  performed,  mar- 
ginal utility  would  rise  and,  so,  price  would  rise.  Accordingly, 
we  conclude  that,  if  the  real  world  gave  us  only  one  ultimate 
cost  good  the  supplying  of  which  involved  a  disutility,  the  prin- 

28G 


CHAPTER   X.     FINAL  PRICE  DETERMINATION. 

ciplc  governing  value  would  be  that  given  above  as  Formula  C; 
that  is,  the  prices  of  products  would  have  to  be  such  that  the 
value  of  the  Ls  entering  into  them  expressed  at  once  the  marginal 
significance  of  Ls  and  the  marginal  disutility  of  supplying  them. 

4.     Third  Approximation. 

Hypothesis : — Several  or  Many  Primary  Cost  Goods,  No  Dis- 
utility Cost,  Supply  or  Output  Fixed. 

In  the  preceding  discussion  our  original  hypothesis  has  been 
considerably  modified ;  but  it  still  shows  more  than  one  dis- 
crepancy from  reality.  Let  us  now  correct  one  of  the  most 
important  of  these.  Even  under  our  modified  hypothesis,  there 
was  but  one  primary  cost  good.  Now,  it  is  hardly  too  much  to 
say  that,  in  the  actual  world,  we  have  to  deal  with  scores  of  pri- 
mary cost  goods,  instead  of  just  one.  It  is,  indeed,  true  that 
economists  are  wont  to  reduce  these  numerous  elements  to 
three,  land,  labor,  and  capital;  and  some  have  even  put  them 
into  two  categories.  But  this  can  be  done  only  by  making 
abstractions  of  more  than  questionable  validity;  and,  anyhow, 
all  admit  that  there  are  at  least  two  primary  factors.  But,  again, 
not  only  are  there  several  or  many  different  primary  cost  goods, 
these  cost  goods  seldom,  if  ever,  are  producing  by  themselves. 
In  practically  all  cases,  several  of  them  are  jointly  engaged  in 
getting  out  some  commodity.  Now,  the  modification  of  our  hy- 
pothesis which  is  made  necessary  because  of  these  facts,  greatly 
increases  the  difficulty  of  defending  any  theory  as  to  the  final 
processes  of  price-determination  which  makes  the  significance 
cr  utility  of  these  primary  cost  goods  play  a  part  in  fixing  their 
prices.  This  point,  being  of  much  importance,  must  receive 
some  elaboration. 

Put  in  general  terms,  the -essence  of  the  difficulty  is  that  the 
Participation  of  different  cost  goods  in  the  same  productive 
process  makes  the  isolating  of  the  share  in  the  product  properlv 
\nputable  to  each  of  the  cooperating  cost  goods  almost,  if  not 

e,  impossible.  The  case  of  a  single  primary  cost  gives  no 
trouble  because,  there  being  but  one  such  cost  good,  we  can  easily 
ascertain  its  economic  product  and,  so,  can  easily  ascertain  what 
significance  or  importance  should  be  imputed  to  it.  Thus,  let  us 
suppose  that  it  takes  3  Ls,  and  nothing  else,  to  produce  an  arm 
chair;  and  that  this  arm  chair  has  a  significance  expressed  by 

237 


PRINCIPLES  OF  ECONOMICS 

$3.  In  such  a  case,  plainly,  3  Ls  must  have  a  significance  of  $3, 
and  i  L,  a  significance  equal  to  1/3  of  this,  or  $i.  But,  when  we 
have  several  primary  cost  goods  engaged  in  the  same  process,  the 
situation  is  wholly  changed.  Thus,  let  us  suppose  that  the  use  of 
a  certain  amount  of  land  plus  a  certain  amount  of  capital  plus 
a  certain  amount  of  labor  plus  a  certain  amount  of  enterprise 
gives  us  a  product  having  a  marginal  significance  of  $75.  On  the 
basis  of  this  proposition  we  can  properly  say  that  all  the  constit- 
uents taken  together  have  a  marginal  significance  expressed  by  $75 ; 
but  we  can  not  say  anything  as  to  the  marginal  significance  of  the 
several  constituents  taken  separately.  We  seem  to  be  in  a  posi- 
tion analogous  to  that  of  a  person  who  should  try  to  solve  an 
equation  containing  four  unknown  quantities  without  other  data 
than  those  supplied  by  the  equation  itself  : — given  v  +  x  -f  y  + 
z  =  $75,  to  find  the  values  of  v,  x,  y,  and  z,  respectively.  Of 
course,  such  a  problem  could  not  be  solved.  Can  ours  be? 
Can  the  several  contributions  of  the  different  factors  in  a  point 
process  be  isolated?  If  not,  would  not  this  fact  make  it  im- 
possible for  us  to  isolate  the  several  marginal  significances  of 
those  factors?  In  the  following  pages,  we  shall  support  the 
negative  answer  to  this  question.  In  other  words,  we  shall  con- 
tend that  the  marginal  significances  of  the  several  primary  cost 
goods  engaged  in  joint  productive  processes  can  be,  and  are, 
isolated.  Further,  we  shall  maintain  that  the  prices  which  these 
primary  cost  goods  tend  to  have  must  be  such  as  express  said 
marginal  significances.  The  presentation  of  the  particular  theory 
as  to  how  this  is  accomplished  which  is  here  advocated,  will 
occupy  the  remainder  of  this  section. 

We  will  begin  this  explanation  by  stating  in  somewhat  formal 
fashion,  the  general  character  of  the  theory  to  be  maintained. 
While,  in  a  great  number  of  cases,  it  is  impossible  really  to 
isolate  tJie  specific  technical  contribution  of  each  particular  fac- 
tor, yet  through  the  automatic  processes  of  the  market  there 
tends  to  be  worked  out  a  system  of  prices  wherein  each  primary 
factor,  or  cost  good,  is  given  a  price,  which  expresses  its  mar- 
ginal significance  and  in  so  doing  supplies  an  index  zvith  re- 
spect to  its  technical  contribution.  In  supporting  this  thesis, 
we  will  first  argue  that  it  is  not  inherently  unreasonable  to  ex- 
pect the  significance  of  each  member  in  a  joint  productive 
process  to  be  isolated,  even  though  it  is  impossible  to  isolate  the 
technical  contribution  made  by  said  factor.  In  order  to  accom- 

288 


CHAPTER  X.    FINAL  PRICE  DETERMINATION. 

plish  this,  we  will  suppose  a  case  of  such  nature  that  it  would 
be  impossible  directly  to  trace  the  technical  contribution  of  each 
factor.  This,  of  course,  would  be  true  where  we  were  dealing 
with  products  of  a  chemical  nature.  It  takes  so  much  charcoal, 
so  much  saltpeter,  and  so  much  sulphur  to  make  black  powder. 
In  such  cases,  manifestly,  it  would  be  impossible  to  separate 
the  physical  or  technical  contribution  of  any  factor  to  the  result. 
If,  then,  we  could  show  that,  even  in  such  cases,  it  would  be 
theoretically  possible  to  ascertain  the  relative  importance  of  each 
of  the  three  contributing  factors,  we  should  thereby  show  that  the 
attempt  to  discover  the  significance  or  importance  of  cooperating 
factors,  although  ignorant  of  their  physical  or  technical  contri- 
bution, is  not  in  itself  absurd.  This  we  will  attempt  to  do. 

Note:  What  is  meant  by  the  "technical -contribution"  of  any 
factor  is  most  easily  brought  out  by  an  illustration  from  our 
chapter  on  Combining  Proportions.  We  there  took  a  combina- 
tion of  two  factors,  As  and  Bs,  and  supposed  the  conditions  to  be 
of  such  a  character  that  we  could  ascertain  precisely  the  increase 
in  the  product  which  resulted  when  we  made  an  increase  in  the 
number  of  Bs, — As  being  left  unchanged.  As  a  matter  of  mere 
technique,  that  increase  would  be  credited  to  the  added  Bs. 
That  is,  the  producer  would  behave  as  if  he  owed  the  increase 
in  product  to  the  added  Bs,  and,  if  necessary,  would  bid  a  price 
for  the  said  Bs  approximating  said  increase  in  product.  In 
the  latter  case,  we  might  'designate  the  product  as  the  technico- 
economic  contribution  of  the  added  Bs. 

In  carrying  out  our  plan  of  trying  to  show  that  under  our 
hypothesis,  it  would  be  theoretically  possible  to  ascertain  the 
importance  or  significance  of  each  of  several  cooperating  factors 
even  when  we  could  not  isolate  their  technical  contribution,  we 
will  start  with  a  simple,  though  very  unreal,  hypothesis,  the  work- 
ing of  which  can  be  followed  theoretically  with  comparative 
ease.  Let  us  suppose  that,  instead  of  needing  only  one  kind  of 
primary  factors  Ls,  we  are  obliged  to  have  three  kinds,  Ls,  Ws, 
and  Rs;  that  our  stock  or  output  of  each  is  definitely  fixed; 
that,  even  after  we  have  utilized  our  whole  stock  of  each,  we 
still  have  unsatisfied  wants  which  the  possible  products  of  those 
primary  cost  goods  could  satisfy;  and  that,  when  our  stocks  of 
these  cost  good  are  most  wisely  utilized,  they  are  devoted  to  the 
making  of  three  products,  which  we  will  designate  as  Pi,  P2, 
and  P3,  respectively.  Let  us  suppose,  further,  that  the  propor- 
tion in  which  Ls,  Ws,  and  Rs  may  be  combined  is  absolutely 
fixed  for  each  product  and  that  these  combining  proportions 

289 


PRINCIPLES  OF  ECONOMICS 

are  at  the  same  time  different  for  each  product, 
being  3,  2,  and  n  for  P1;  4>  10,  and  2  for 
P2;  and  10,  3,  and  3  for  P3.  Finally,  let  us  suppose  that,  when 
equilibrium  has  been  fully  established,  the  comparative  impor- 
tances of  a  unit  of  our  three  products  show  a  ratio  of  64  to  34 
to  31 ;  so  that,  if  Pi  were  to  have  a  price  of  62  cents,  P2  would 
have  one  of  34  cents,  and  P3  one 'of  31  cents.  Now  we  have 
before  us  a  set  of  conditions  under  which  there  seems  to  be 
no  possibility  of  directly  ascertaining  the  technical  contribution 
of  Ls  or  Ws  or  Rs.  First,  we  have  no  cases  where  one  or  an- 
other of  these  produces  by  itself.  They  are  always  working 
together.  Secondly,  we  cannot  employ  a  method  which  in  the 
present  order  is  feasible  for  some  cases,  anyhow,  and  is  believed 
by  some  writers  to  be  everywhere  applicable,  namely,  the  plan 
of  increasing  by  small  increments  the  proportion  of  one  of  the 
factors  while  the  others  remain  constant,  observing  the  increase 
in  product  which  results,  and  crediting  that  increment  in  pro- 
duct to  the  factor  which  has  been  increased  in  amount.  I  say 
we  cannot  emplo}7'  this  method  in  the  case  before  us  for  the 
reason  that  our  hypothesis  shuts  out  all  'but  the  combining  pro- 
portions named;  that  is,  if  we  are  going  to  produce  Pi  at  all,  we 
must  use  just  3  Ls,  2  Ws,  and  n  Rs;  so  for  P2  we  must  use 
just  4  Ls,  10  W'S,  and  2  Rs;  and  for  P3,  just  10  Ls,  3  Ws,  and 
3  Rs.  No  other  combinations  than  these  would  do  the  work. 
Yet,  in  spite  of  the  fact  that,  under  the  conditions  named,  we 
could  not  isolate  in  any  degree  the  technical  contribution  of  Ls 
or  Ws  or  Rs,  there  can  be  no  doubt  whatever  that,  given  the 
information  contained  in  our  hypothetical  conditions,  we  could 
ascertain  with  absolute  precision  the  real  significance  of  Ls,  Ws, 
and  Rs,  taken  separately. 

In  the  first  place,  on  the  basis  of  those  conditions,  we  could 
set  forth  the  following  propositions  with  respect  to  the  pro- 
ductive capacities  of  our  factors  L,  W,  and  R: 

3  Ls  plus    2  Ws  plus  IT  Rs  will  -produce  I  Pi 

4  Ls  plus  10  Ws  plus    2  Rs  will  produce  i  P2 
10  Ls  plus    3  Ws  plus    3  Rs  will  produce  i  P3 

In  the  second  place,  if  we  combine  these  propositions  with 
the  data  as  to  prices  derived  from  the  last  condition  given  above, 
and  let  L,  W,  and  R  signify  the  money  value  of  these  factors 
we  should  have  the  following  equations: 

290 


CHAPTER  X.    FINAL  PRICE  DETERMINATION 

3  Ls  +    2  Ws  -f  ii  Rs  =  62  cents 

4  Ls  +  10  Ws  -f-    2  Rs  =  34  cents 
10  Ls  +    3  Ws  -f    3  Rs  =  31  cents 

Solving  these  equations  for  each  factor  we  have  the  follow- 
ing results : 

value  i    L  =  I  cent 

value  i  W  =  2  cents 

value  I    R  =  5  cents 

That  is,  in  view  of  the  supposed  facts,  i  L  has  a  significance 
or  importance  to  us  of  i  cent;  i  W,  a  significance  or  importance 
of  2  cents;  and  i  R,  a  significance  or  importance  of  5  cents. 

The  discussion  just  completed  has  shown  that  an  economic 
order  is  conceivable  under  which  there  are  several  primary  cost 
goods  always  acting  jointly  in  production  and  acting  under  such 
conditions  that  it  is  impossible  to  isolate  the  particular  technical 
contribution  of  each  of  said  cost  goods,  while,  after  all,  each  of 
these  cost  goods  really  has  a  specific  and  precise  significance  or 
importance  of  its  own  in  view  of  its  relation  to  product,  which 
specific  significance  could  easily  be  ascertained,  supposing  certain 
data  available.  There  is,  therefore,  nothing  inherently  unreason- 
able in  anticipating  that  by  some  process  or  other  the  specific 
significances  of  different  cooperating  cost  goods  would  be  isolat- 
ed, even  though  their  technical  contributions  could  not  be  iso- 
lated. 

But  we  have  not  yet  finished  our  task.  We  have  still  to 
show  that  the  several  significances  which  the  Ls^  Ws,  and  Rs  of 
our  hypothesis  unquestionably  have  would  tend  to  be  completely 
isolated  and  ascertained,  in  that  the  prices  which  Ls,  Ws,  and  Rs 
would  tend  to  have  under  the  automatic  working  of  the  laws 
of  price  would  necessarily  be  such  prices  as  would  express  said 
significances  of  Ls,  Ws,  and  Rs.  Stated  still  more  specifically, 
we  have  to  show  that  our  Ls,  Ws,  and  Rs,  which  quite  certainly 
would  have  real  significances  of  i  cent,  2  cents,  and  5  cents, 
respectively,  would  quite  as  certainly  tend  to  have  prices  of 
i  cent,  2  cents,  and  5  cents,  respectively.  The  theory  here  ad- 
vocated with  respect  to  the  process  whereby  this  result  would  be 
accomplished,  may  be  stated  in  a  sentence.  The  presence  on  the 
market  of  prices  for  Ls,  Ws,  and  Rs  other  than  those  which  ex- 
press their  true  significances  would  itself  be  sufficient  to  set  in 
motion  a  scries  of  reactions  tending  to  replace  said  prices  with 
-those  which  did  express  said  true  significances,  namely,  i  cent, 

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PRINCIPLES  OF  ECONOMICS 

2   cents,   and   5    cents*   and   these   reactions   could   not   cease    tilt 
those  prices  had  been  established. 

In  undertaking  to  establish  the  above  contention,  we  will  begin 
by  supposing  that,  at  some  particular  time,  the  actual  prices  of 
these  cost  goods  were  different  from  the  prices  required  to  ex- 
press their  marginal  significances,  being,  let  us  say,  4  cents  for 
Ls,  3  for  Ws,  and  i  for  Rs.  What  now  would  happen?  First, 
the  conditions  named  would  lead  entrepreneurs  to  discontinue 
producing  P2s  and  P3s,  and  to  devote  their  entire  resources 
to  porducing  Pis ;  for,  with  the  prices  of  primary  cost  goods 
named  Pas  would  show  a  special  profit  of  33  cents,  while  P2s 
and  PsS  would  show  losses  of  14  and  21  cents,  respectively. 
But,  secondly,  this  concentrating  of  all  production  on  Pi  would 
throw  several  Ls  and  Ws  out  of  use  altogether;  since  fewer  of 
them  are  needed  in  producing  a  certain  number  of  Pis  than  in 
producing  an  equal  number  of  P2s  and  P3s.  This  would  neces- 
sarily bring  about  a  lowering  of  the  prices  of  Ls  and  Ws.  Fur- 
ther, this  lowering  would  have  to  go  on  until  it  had  become 
great  enough  to  bring  back  the  Ls  and  Ws  that  had  been  drawn 
off  into  the  producing  of  the  new  Pis;  since  otherwise  the  entire 
stock  of  Ls  and  Ws  could  not  be  utilized, — Rs  being  too  few 
to  match  them  unless  they  are  used  in  producing  P2s  and  P3s. 
Supposing,  now,  that  the  prices  of  Ls  and  Ws  have  gone  low 
enough  to  bring  them  back  from  the  production  of  PiS, — the 
price  of  Rs  being  unchanged — ,  another  series  of  reactions  would 
promptly  be  set  up.  First,  the  excessively  low  price  of  'Rs, 
combined  with  the  fact  that  prices  O'f  Ls  and  Ws  had  been 
lowered  so  that  they  were  not  much  above  normal,  would  result 
in  giving  producers  a  considerable  surplus  over  cost  of  pro- 
duction. But  this  'surplus  would  lead  producers  to  compete  with 
one  another  for  the  control  of  the  several  factors  of  production ; 
and  this  competition  for  the  factors  of  production  would  neces- 
sarily fall  entirely  upon  Rs,  since  it  is  barely  'possible  to  find 
use  for  our  stock  of  Ls  and  Ws  even  at  their  present  prices. 
In  consequence,  the  price  of  Rs  will  be  raised  somewhat  above 
its  former  level.  That  is,  two  complementary  series  of  reac- 
tions will  'have  been  set  up:  (i)  one  lowering,  in  some  measure, 
the  abnormally  high  prices  of  Ls  and  Ws,  and  (2)  one  raising, 
in  some  measure,  the  abnormally  low  price  of  Rs.  But,  now, 
supposing  that  even  these  new  prices  are  divergent  from  the 
true  significance  prices, — though  less  so  than  were  the  former 

292 


CHAPTER  X.    FINAL  PRICE  DETERMINATION 

ones — ,  at  once  our  twofold  cycle  of  reactions  will  again  be  set 
up.  For  the  new  higher  price  of  Rs  will  again  make  unprofit- 
able the  production  of  the  more  expensive  PsS  and  P3s.  Pro- 
duction will,  therefore,  again  leave  these  commodities, — though 
not  to  the  same  extent  as  before — ,  and  go  to  the  making  of 
Pis,  which  procedure  will  once  more  throw  out  of  use  some 
Ls  and  Ws, — though  fewer  than  the  first  time.  As  before,  this 
will  cause  a  lowering  of  the  prices  of  Ls  and  Ws  to  a  point 
which  will  draw  them  back  to  their  former  employment  in 
making  P2s  and  P3s.  And,  now,  the  second  half  of  our  two-fold 
cycle  of  reactions  will  again  be  started.  Costs  are  still  abnor- 
mally low,  thus  giving  producers  a  surplus,  which  surplus  will 
stimulate  competition  for  the  possession  of  the  primary  cost 
goods.  This  competition,  as  before,  will  fall  entirely  upon  Rs ; 
and,  hence,  the  price  of  Rs  will  again  be  pulled  up.  And  this 
brings  us  again  to  our  starting  point  and  sets  our  reaction  cycle 
in  motion  once  more:  (i)  the  production  of  P2s  and  P8s  unprofit- 
able; (2}  some  Ls  and  Ws  out  of  use;  (3)  a  fall  in  the  prices  of 
Ls  and  Ws;  (4)  a  surplus  profit;  (5)  competition  for  Rs;  and 
(6)  a  higher  price  for  Rs.  Thus,  we  have  a  cycle  of  reactions 
the  first  half  of  which  lowers  the  price  of  Ls  and  Ws,  while 
the  second  half  raises  the  price  of  Rs;  and  these  reactions  can- 
not cease  till  all  three  prices  are  just  where  they  need  to  be  in 
order  that  each  should  express  the  true  significance  of  the 
corresponding  factor- — that  is,  until  they  are  I  cent  for  Ls,  2 
cents  for  Ws,  and  5  cents  for  Rs. 

In  the  preceding  argument  for  our  contention  that,  under  our 
present  hypothesis,  the  automatic  working  of  things  would  tend 
to  give  each  one  of  several  cooperating  factors  just  that  price 
which  expresses  its  real  significance,  we  supposed  the  number 
of  both  factors  and  products  to  be  limited  to  three.  This  seemed 
necessary  in  order  to  insure  a  clear  comprehension  of  the  argu- 
ment. But,  in  the  real  world,  the  different  factors  are  scores 
in  number  and  of  the  different  products  there  are  many  'hundreds. 
Would  a  corresponding  change  in  our  hypothesis  alter  the 
course  of  our  reasoning?  Surely  not.  There  was  nothing  in 
that  reasoning  which  depended  on  the  number  of  either  factors 
or  products.  This  change  would,  of  course,  make  the  working 
out  a  slower  process  and  would  make  the  results  less  precise ; 
but  the  same  tendency  would  prevail.  It  follows,  then,  that,  if 
our  present  hypothesis  were  aruadequate  representation  of  the 

293 


PRINCIPLES  OF  ECONOMICS 

facts,  we  should  have  a  principle  closely  analogous  to  the  first 
of  the  three  formulae,  already  discussed,  only  it  would  now  need 
to  be  modified  so  as  to  recognize  the  existence  of  many  primary 
cost  goods.  Precisely  stated,  this  principle  would  give  us  the 
following : 

Formula  D.  //  there  were  many  primary  cost  goods,  and 
these  were  strictly  limited  in  amount  or -output  and  had  no  dis- 
utility cost,  complete  equilibrium  among  the  price-making  forces 
would  be  reached  when,  and  only  when,  there  had  been  estab- 
lished a  coherent  system  of  interdependent  prices  such  that  (i) 
the  prices  of  marginal  products  expressed  their  marginal  sig- 
nificances; (2)  the  prices  of  the  primary  cost  goods  expressed 
their  significances  as  realised  in  marginal  products;  and  (3) 
the  prices  of  supra-marginal  products  equalled  the.  money  value 
of  the  primary  cost  goods  entering  into  them. 

5.     Fourth  Approximation. 

Hypothesis : — Several   or  Many   Primary   Cost   Goods,   Disutility 
Costs,  Supply  or  Output  Variable. 

a.  Prices  of  Primary  Cost  Goods  would  still  tend  to  Express 
their  Marginal  Significances. 

Thus  far  in  correcting  our  original  hypothesis  by  admitting 
the  existence  of  many  primary  cost  goods,  we  have  applied  this 
correction  to  the  first  form  of  our  hypothesis,  i.  e.,  the  form  in 
which  the  stock  or  output  of  factors  is  fixed.  But,  obviously,  this 
will  not  suffice.  We  must  take  into  account  not  only  the  fact  that 
there  are  many  primary  cost  goods,  but  also  the  fact  that  not  a 
few  of  these  depend1  on  human  choice,  and,  hence,  vary  in 
quantity.  Would  the  new  modification  invalidate  the  reasoning 
on  which  is  based  our  conclusion  that  the  price  of  each  primary 
cost  good  would  tend  to  be  that  one  which  would  express  its 
marginal  significance?  I  think  not.  Though,  the  output  of 
primary  cost  goods  would  be  subject  to  modification,  nevertheless 
at  any  one  time,  at  any  moment  it  would  be  temporarily  deter- 
minate. Now,  under  the  working  of  the  processes  already  de- 
scribed, the  temporarily  determinate  output  would  have  its  price 
fixed  at  a  point  which  expressed  its  marginal  significance ;  and 
the  only  way  whereby  the  price  thus  fixed  could  be  disturbed 
would  be  through  a  material  change  in  the  output  of  the  goods 
in  question.  Such  a  change  we  have  assumed  to  be  possible  and 

294 


CHAPTER  X.    FINAL  PRICE  DETERMINATION 

that  in  response  to  economic  motives.  This  could)  be  only  on 
condition  that  the  price  temporarily  reached  was  above  or  below 
the  marginal  disutility  of  supplying  said  cost  goods.  Let  us 
suppose  it  to  be  above.  In  that  case,  the  output  of  said  goods 
would  be  increased.  But  this  would  merely  mean  a  new  tem- 
porarily-fixed stock,  the  price  of  which  would  quickly  come  to 
coincide  with  its  marginal  significance  under  the  working  of  the 
processes  already  outlined.  Should  this  new  price  still  prove  too 
high,  the  operation  would  be  repeated  until  full  equilibrium  had 
been  reached  and  that  at  a  price  which  was  as  low  as  the  marginal 
significance. 

The  above  reasoning  assumes  that  the  provisionally  deter- 
mined price,  while  coinciding  with  marginal  significance,  was 
above  marginal  disutility.  It,  therefore,  leaves  the  alternative 
hypothesis  of  a  price  below  marginal  disutility  still  to  dispose 
of.  This,  however,  offers  no  difficulty.  Reasoning  exactly  anal- 
ogous to  that  employed  would  show  that  final  equilibrium  among 
the  price-making  forces  could  be  reached  only  when  price  had 
come  to  coincide  with  marginal  significance  as  before. 

b.  Prices  of  Primary  Cost  Goods  would  necessarily  tend  to 
Express  their  'Marginal  Disutilities. 

We  have  now  completed  our  argument  in  so  far  as  it  is  con- 
cerned with  the  contention  that  the  prices  of  primary  cost  good's 
would  tend  to  be  such  as  expressed  the  marginal  significance  of 
those  cost  goods.  In  spite  of  the  difficulty  or  even  impossibility 
of  tracing  the  technical  contribution  of  the  different  cost  goods, 
things  would  tend  to  work  out  automatically  so  that  the  prices 
of  those  cost  good's  would  express  their  true  significance.  Our 
formula,  however,  is  not  yet  quite  complete.  We  have  still  to 
provide  for  one  other  factor.  When,  to  our  original  hypothesis 
that  there  was  but  one  primary  cost  good,  the  condition  was  added 
that  this  primary  cost  good  had  a  disutility  cost,  we  were  obliged 
to  enlarge  our  formula  so  as  to  take  in  the  point  that  the  price 
of  Ls  would  have  to  express  the  disutility  of  supplying  them  as 
well  as  the  utility  or  significance  of  their  marginal  product.  How 
about  our  new  case  at  this  point?  Does  it  differ  materially  from 
the  former  one?  I  think  not.  Whether  our  primary  cost  goods 
were  many  or  few,  if  the  supplying  of  any  or  all  of  them  involved 
a  disutility  cost,  and  if  our  capacities  and  wants  had  the  relation 
which  was  brought  out  in  the  third  alternative  on  page  284,  the 

295 


PRINCIPLES  OF  ECONOMICS 

prices  of  such  primary  cost  goods  as  had  a  disutility  cost  would 
surely  tend1,  in  the  long  run,  to  express  the  disutilities  of  supply- 
ing them.  For,  with  respect  to  disutilities,  the  new  element  in 
our  hypothesis,  namely,  the  fact  that  we  have  several  cost  goods 
instead  of  one,  has  no  tendency  to  increase  the  difficulties  of  the 
case,  as  it  did  in  the  case  of  their  marginal  significances.  The 
reason  why  the  change  from  one  to  several  primary  cost  goods 
gave  us  trouble  in  connection  with  the  problem  of  their  signifi- 
cance is  that  in  production,  these  goods  act  jointly,  and,  therefore, 
it  is  difficult  or  impossible  to  isolate  the  particular  contribution  of 
each  one.  But,  with  the  disutility  aspect  of  cost  goods,  the 
situation  is  very  different.  Cost  goods  engage  in  production 
jointly,  cooperatively;  but  they  are  produced  individually.  For 
example,  we  have  to  work,  and  so  have  to  undergo  the  disutilities 
involved,  as  individuals.  Accordingly,  the  reasons  employed!  in 
our  earlier  case  to  show  that  prices  must  express  the  disutility 
involved  in  supplying  the  primary  cost  goods,  are  fully  applicable 
to  this  second  case.  If  the  price  of  any  particular  primary  cost 
good  fails  to  be  as  great  as  the  marginal  disutility  involved  in 
supplying  it,  the  supply  will  become  deficient  and  price  must 
rise.  On  the  other  hand,  if  the  price  of  such  cost  good  is  greater 
than  the  marginal  disutility  involved  in  supplying  it,  the  supply 
will  become  excessive,  and  the  price  must  fall. 

If,  now,  we  summarize  the  results  of  this  last  discussion  in  a 
single  statement  as  in  preceding  cases,  we  shall  have  the  follow- 
ing: 

Formula  E.  //  there  were  many  primary  cost  goods  and  the 
supplying  of  some  or  all  of  these  involved  a  disutility  sacrifice, 
while  our  wants  and  capacities  were  so  related  that  the  signifi- 
cance and  the  disutility  of  our  actual  output  varied  at  something 
like  the  same  rate,  then  complete  equilibrium  among  the  price- 
making  forces  would  be  reached  when,  and  only  when,  there  had 
been  established  a  coherent  system  of  interdependent  prices  such 
that  (i)  the  prices  of  marginal  products  expressed  both  their  own 
marginal  utility  and  the  disutilities  of  the  cost  goods  entering  into 
them;  (2)  the  prices  of  the  primary  cost  goods  expressed  their 
significances  as  realized  in  some  marginal  product,  and  also  the 
disutilities  of  supplying  them  if  such  disutilities  existed ;  and  (3) 
the  prices  of  supra-marginal  products  equalled  the  money  value 
of  the  primary  cost  gods  entering  into  them. 

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CHAPTER  X.    FINAL  PRICE  DETERMINATION 

6.     The   Formula    for   Final    Price-Determination   Under   Actual 
Conditions. 

We  have  considered  the  process  of  final  price-determination 
under  a  series  of  hypotheses,  beginning  with  one  which  involved 
the  simplest  conditions  and  by  successive  changes  bringing  it 
down  to  the  form  which  .appeared  under  the  preceding  division. 
That  our  hypothesis  as  finally  modified  covers,  in  a  general  way, 
the  present  system,  there  can  be  no  material  doubt.  There  re- 
mains the  question,  however,  whether  there  is  still  sufficient  dif- 
ference between  that  hypothesis  and  the  present  order  to  invali- 
date the  conclusion  which  has  been  reached.  (More  especially, 
were  not  the  conditions  of  our  hypothesis  in  respect  to  the 
number  of  primary  cost  goods  and  the  number  of  products  so 
extremely  simplified  as  to  destroy  the  soundness  of  our  con- 
clusion with  respect  to  the  relation  between  marginal  significance 
and  prices  when  applied  to  the  present  order?  Though  I  must 
answer  this  question  in  the  negative,  I  am  quite  prepared  to 
admit  that,  because  of  the  difference  between  the  actual  order 
and  our  hypothetical  one  which  was  just  brought  out,  actual 
prices  express  the  marginal  significances  of  the  primary  cost 
goods  with  much  less  precision  than  they  would  under  our 
hypothetical  conditions,  and,  especially,  that  they  follow  changes 
in  marginal  significance  much  less  quickly  than  they  would  under 
said  hypothetical  condition.  Nevertheless,  I  should  insist  that  this 
objection  does  not  furnish  sufficient  ground  for  relinquishing  the 
belief  that,  in  the  long  run,  prices  of  the  character  indicated  would 
be  substantially  realized.  If  the  theory  which  we  have  propounded 
depended  for  its  workings  in  any  considerable  degree  upon  human 
sagacity,  upon  the  skill  of  producers  in  making  a  nice  analysis  of 
industrial  processes  and  in  working  out  complicated  mathematical 
calculations,  it  would  be  very  questionable  indeed  whether  we 
could  expect  the  principle  stated  to  have  any  appreciable  realization 
in  the  present  order.  But  the  student  will  remember  that  our 
theory  builds  almost  entirely  upon  the  automatic,  spontaneous, 
working  of  things.  It  is  hardly  too  much  to  say  that  we  require 
of  producers  nothing  more  than  that  they  should  be  able  to  know 
the  prices  of  products  and  cost  goods,  and  should  be  able  to 
determine  on  the  basis  of  these  prices  what  particular  product 
they  had  better  produce  and  what  particular  combination  of  fac- 
tors would  yield  the  greatest  profit.  Provided  they  can  fulfil 
these  very  limited  requirements,  the  spontaneous  pursuit  of  their 

297 


PRINCIPLES  OF  ECONOMICS 

own  self  interest  will,  according  to  our  theory,  work  out  auto- 
matically the  result  claimed.  It  thus  appears  that  the  mere  num- 
bers of  cost  goods  and  products,  and  the  vastness  of  the  scale  of 
production,  and  the  highly  complicated  character  of  economic 
relations  would  not  necessarily  furnish  grounds  for  anticipating 
the  failure  of  our  principle. 

If  we  turn  to  the  case  of  disutilities  the  answer  is  not  mater- 
ially different.  That  the  price  of  primary  cost  goods  tends  to 
express  the  marginal  disutility  involved  in  supplying  them,  in  one 
sense  of  the  word,  namely,  in  the  sense  that  the  disutilities 
and  the  price  will  tend  to  coincide,  probably  every  one  will 
admit.  Even  if  price  were  entirely  determined  by  marginal 
significance  it  would  tend  to  coincide  with  marginal  disutility, 
since  the  latter  would  proceed  to  adjust  itself  to  said  price. 
But  this  sort  of  coincidence  between  price  and  disutility  is 
not  the  one  claimed  in  our  principle.  It  is  there  meant  that  price 
must  express  marginal  disutility  in  the  sense  that  said  marginal 
disutility  has  a  real  share  in  fixing  price  just  as  truly  as  has 
marginal  significance.  This  means  that  marginal  disutility  plays 
some  part  both  in  keeping  price  as  high  as  it  is  and  in  keeping 
it  as  low  as  it  is.  The  difference  between  such  a  case  and  that 
of  a  fixed-supply  or  fixed-output  good  in  which  latter  case  the 
coincidence  of  price  and  cost  are  effected  by  the  mere  adjust- 
ment of  cost  to  price  is  best  seen  by  comparing  the  case  of  the 
special  brand  of  tea  with  that  of  silver  as  represented  on  paec 
255.  In  the  former,  a  rise  of  two  steps  in  the  demand  schedule 
causes  a  two-step  rise  in  price ;  and,  so,  a  fall  of  two  steps  in 
demand  causes  a  two-step  fall  in  price.  But  with  silver,  a 
two-step  rise  in  the  demand  schedule,  causes  only  a  one-step 
rise  in  price — the  larger  rise  being  shut  out  by  increased  produc- 
tion. So,  a  two-step  fall  in  demand  causes  only  a  one-step  fall 
in  price, — the  larger  fall  being  shut  out  by  diminished  pro- 
duction. 

This  illustration  brings  out  the  real  crux  of  the  matter. 
Whether  or  not  disutility  has  any  real  share  in  determining  price 
in  the  cases  before  us  turns  on  whether  changes  in  price  cause 
changes  in  output  sufficiently  great  to  alter  price.  Does  the 
failure  of  the  rate  of  interest  to  be  high  enough  to  express  the 
capitalist's  estimate  of  the  disutility  of  supplying  it  cause  accumu- 
lation to  fall  off  till  the  rate  rises?  On  the  other  hand,  does 
the  fact  that  the  rate  of  interest  has  remained  some  time  above 

298 


CHAPTER  X.    FINAL  PRICE  DETERMINATION 

a  rate  which  expresses  the  capitalist's  estimate  of  the  disutility- 
cause  accumulation  to  increase  till  the  rate  falls?  If  these 
questions  must  be  answered  in  the  affirmative,  then  in  the  case 
of  one  ultimate  cost  good — waiting  power — disutility  certainly 
plays  a  part  in  price-determination.  The  question  is  probably- 
one  which  can  never  receive  a  decisive  answer;  but  at  present 
most  persons  would  answer  it  affirmatively. 

What  now,  is  to  be  said  with  resppct  to  the  other  most 
important  cases  of  ultimate  cost  goods  the  existence  of  which 
depends  on  human  choice,  viz.,  most  types  of  labor  service? 
Here  the  test  is  the  same  as  before.  Do  changes  in  wages 
sufficiently  influence  the  supply  of  labor  services  to  cause  3 
reaction  which  alters  those  wages?  Here  it  would  be  necessary 
to  distinguish  a  short-time  and  a  long-time  normal.  Some 
certainly,  would  be  disposed  to  affirm  that  for  periods  of  mod- 
erate length,  the  supply  of  labor  services,  particularly  those  of 
the  most  common  type,  are  substantially  fixed, — about  so  many 
days  of  labor  will  be  offered  whatever  the  rate  of  wages.  If  a 
price  of  $2  per  day  can  be  had,  well  and  good;  but  if  it  turn? 
out  to  be  only  $1.50,  we  must  make  the  best  of  it.  I  am  not 
entirely  satisfied  that  this  is  true.  I  am  disposed  to  believe 
that  even  for  periods  of  moderate  length  enough  laborers  can, 
and  often  do,  refuse  to  accept  a  wage  which  is  below  their  esti- 
mate of  the  disutility  involved  in  supplying  the  labor  to  cause 
a  rise  in  wages  or  at  least  to  check  a  fall.  However,  I  will  not 
press  the  matter,  and  surely  would  not  claim  that  this  is  always 
the  way  things  work. 

As  respects  the  long-time  normal  for  wages,  the  case  for  our 
principle  is  more  easily  made  and  more  commonly  secures  a 
verdict.  In  fact,  the  great  majority  of  economists  accept  more 
or  less  fully  the  doctrine  that  in  the  long  run,  under  the  work- 
ing of  the  principles  of  population,  the  wages  of  common  labor 
are  kept  at  a  point  which  expresses,  roughly  anyhow,  the  stand- 
ard generally  accepted  by  the  class  interested  as  to  what  a 
laborer's  income  must  be  to  make  his  life  worth  while.  If  wages 
are  below  this  figure,  marriages  are  postponed,  or  in  other  ways 
population  is  restricted,  thus  diminishing  the  supply  of  labor 
power  and  so  causing  a  rise  in  wages.  If  wages  are  above  the 
disutility  minimum,  an  exactly  opposite  movement  takes  place, 
the  supply  of  labor-power  increases  and  the  price  of  labor  falls. 

In  the    last    paragraph,    it    was  pointed  out  that  economists 

29Q 


PRINCIPLES  OF  ECONOMICS 

generally  recognize  that  in  the  case  of  common  labor,  anyhow, 
the  working  class  conception  of  the  disutility  cost  of  labor 
plays  a  part  in  fixing  the  long-run  normal  of  wages.  This  seems 
far  more  certainly  true  in  the  case  of  the  higher  forms  of  labor. 
In  these  forms  the  workers  always  have  as  a  last  resort  the 
alternative  of  dropping  into  a  lower  calling.  The  result  is  that 
each  of  the  higher  callings  gradually  develops  a  standard  which 
is  conceived  as  necessary  by  those  who  join  its  ranks.  If  for  a 
time  that  standard  is  passed,  then  a  more  than  usually  rapid 
inflow  of  recruits  from  the  oncoming  generation  makes  supply 
excessive  and  causes  a  fall  in  the  remuneration.  On  the  other 
hand,  if  for  a  time  the  standard  is  not  reached,  recruiting  falls 
off  and  the  remuneration  has  to  rise. 

From  all  this  it  follows  that,  in  real  life,  the  failure  of  price 
to  express  the  disutilities  of  supplying  the  ultimate  factors  does 
influence  the  supply  of  those  factors  sufficiently  to  cause  marginal 
significance  to  rise  or  fall  and,  so,  to  cause  price  to  rise  or  fall. 
This  being  true,  a  formula  for  the  final  determination  of  prices, 
if  it  is  to  be  adequate,  must  include  an  affirmation  that  the  prices 
of  the  primary  cost  goods  must  tend  to  be  such  as  will  express 
the  disutilities  involved  in  supplying  those  goods.  But  we  have 
already  seen  that  an  adequate  formula  will  affirm  that  the  prices 
of  the  primary  cost  goods  must  express  their  marginal  signifi- 
cances as  embodied,  in  consumption  products.  Accordingly,  we 
are  brought  finally  to  the  conclusion  that  Formula  E,  given  at  the 
close  of  the  preceding  division  of  this  section,  is  substantially  the 
correct  formula  for  the  final  principle  according  to  which,  under 
the  present  order  prices  tend  to  be  regulated. 

ILLUSTRATIVE  PROBLEMS. 

1.  Some  writers  are  accustomed  to  speak  as  if  the  value  of 
each  particular  kind  of  goods  were  determined  by  its  own  mar- 
ginal utility  solely. 

Show  that,  evrn  if  it  be  admitted  that  utility  is,  ultimately 
speaking,  the  only  cause  affecting  values,  the  position  alluded  to 
is  after  all  quite  untenable. 

2.  Some  writers  more  cautious  than  the  last  are  accustomed 
to  speak  as  if  the  value  of  every  particular  kind  of  cost  goods, 
e.  g.,  iron,  copper,  lumber,  etc.,  were  determined  by  the  marginal 
utility   of   the    marginal   commodity   produced    from   it,    without 
regard  to  anything  else. 

Show  that  this  position  also  is  quite  untenable,  though  it  be 
admitted,  as  before,  that  the  sole  ultimate  cause  influencing 
value  is  utility. 

300 


CHAPTER  X.    FINAL  PRICE  DETERMINATION 

3.  Some  writers  are  accustomed  to  speak  as  if  the  value  of 
every  particular  durable  commodity  were  determined  entirely  by 
capitalizing  its  own  income  of  money  or  services. 

(a)  Show  that  this,  is  quite  untenable. 

(b)  .  Show   that   it   would    still    be   untenable   if    we   were  to 
substitute    for   "its   own   income'   "the   income   of   the   marginal 
member  of  its  class. M 

(c)  Make  an  extreme   hypothesis  under  which  it   might  be 
maintained  that  there  was  not  a  single  case  of  a  durable  pro- 
duced good  in  which  the  value  of  said  good  was  what  it   was 
because  the  income  was  what  it  was. 

4.  An  eminent  American  economist  who  formally  rejects  the 
doctrine  that  the  values  of  the  ultimate  cost  goods,  labor,  wait- 
ing, etc.,  are  determined  by  theii    productivity,  nevertheless  ex- 
presses the  opinion  that  "interest  is  determined  proximately  by 
the    increase    of    product    resulting    from    the    last    or    marginal 
application  of  capital." 

Are  the  two  opinions  consistent? 


Section  B.    The  Labor  Theory  of  Value. 

The  student  is  of  course  aware  that  one  of  the  most  vig- 
orous of  the  revolutionary  or  reform  agitations  of  our  day 
has  for  its  object  the  establishment  of  an  economic  order  known 
as  Socialism, — meaning  thereby  an  order  in  which  economic  co- 
operation should  not  be  spontaneous  as  today  but  rather  should 
be  formal,  conscious,  organized, — an  order  in  which  the  state 
should  be  the  sole  entrepeneur,  as  also  the  sole  capitalist  and 
landlord.  Now  this  socialism  is  in  essence  merely  a  system  of 
economic  organization,  not  a  body  of  economic  doctrines. 
Further,  one  can  with  entire  consistency  advocate  this  social- 
istic order  without  holding  any  peculiar  economic  doctrines. 
Still,  as  a  matter  of  fact,  one  or  more  peculiar  economic  doc- 
trines have  played  a  very  great  part  in  securing  the  acceptance 
of  socialistic  ideas.  Indeed,  without  those  doctrines,  it  seems 
almost  certain  that  the  scheme  would  have  gained  few  converts. 
For  the  strength  of  the  agitation  has  been  its  denunciation  of 
the  present  order  as  grossly  unjust,  as  one  in  which  the  real 
producers  of  wealth  have  been  robbed  almost  completely  by 
hordes  of  parasites  in  the  shape  of  middlemen,  capitalists,  land- 
owners, et  alteri.  Now,  the  chief  theoretic  basis  of  this  con- 
tention as  actually  argued  has  been  a  particular  theory  of  value 
together  with  a  theory  of  profits  which  may  be  looked  on  as 
little  more  than  a  corollary  from  said  theory  of  value.  This 
theory  of  value  is  known  as  the  labor  theory.  It  teaches  that 

301 


PRINCIPLES  OF  ECONOMICS 

the  ratio  in  which  goods  exchange  is  determined  entirely  by 
the  ratio  between  their  labor  costs, — is  in  fact  the  reciprocal 
of  the  ratio  between  their  labor  costs.  Thus,  if  a  certain  table 
costs  5  days'  labor  while  25.8  grains  of  gold  costs  a  half  day's 
labor,  i.  e.,  if  the  ratio  of  their  labor  costs  is  as  5  to  y>.  or  10  to 
I,  then  their  exchange  ratio  will  be  1  to  10,  i.  e.,  1  table  will  be 
worth  10  times  25.8  grains  of  gold,  or,  if  \ve  call  the  latter  one 
dollar  will  be  worth  10  dollars. 

This  illustration  is  particularly  useful  in  that  it  enables  us  to 
make  Marx's  way  of  teaching  this  labor  doctrine  stand  out 
ivith  peculiar  distinctness.  A  dollar's  worth  of  gold  costs  one- 
half  day's  labor,  or  two  dollars'  worth  costs  a  whole  day.  Hence 
a  day's  labor  will  put  into  any  product  whatsoever  two  dollars 
of  value. 

In  interpreting  this  theory  of  Marx,  the  student  must  guard 
against  supposing  that  Marx  makes  the  value  of  a  thing  to 
depend  on  current  labor  alone.  For  example,  if  a  man  takes 
100  feet  of  lumber,  a  pound  of  nails,  etc.,  and  in  one  day  makes 
a  shed,  Marx  would  not  say  that  the  shed  will  be  worth  just  $2. 
It  is,  of  course  necessary  to  include  also  the  labor  spent  pro- 
ducing the  lumber,  the  nails,  etc., — past  labor.  Goods  of  this  sort 
are  commonly  called  capital,  and  Marx  so  designates  them  and 
characterizes  them  as  congealed  labor.  It  is  thus  evident  that 
Marx  recognizes  the  fact  that  capital  helps  to  determine  values, 
only  it  is  capital  viewed  as  the  embodiment  of  past  labor. 

But  perhaps  the  student  will  now  wonder  how  Marx's  view 
differs  from  that  of  other  people.  The  answer  is  that,  while 
Marx  admits  the  influence  of  capital,  he  does  not  admit  the 
influence  of  the  waiting  or  other  sacrifice  involved  in  supplying 
capital.  Thus,  if  the  lumber,  nails,  etc.,  in  the  above  example 
had  cost  the  labor  of  one  day  and  a  half,  Marx  would  say  that 
the  value  of  the  shed  must  be  $5,  i.  e.,  $3  for  the  materials — 
congealed  labor — and  $2  for  the  labor ;  whereas  every  one  knows 
that  the  materials  would  have  cost  something  more,  perhaps  $4, 
because  of  the  waiting  and  other  sacrifices  involved  in  supplying 
such  capital  goods. 

As  a  clear  understanding-  of  Marx's  doctrine  is  necessary  to 
its  refutation,  we  will  introduce  here  some  illustrative  problems. 

ILLUSTRATIVE  PROBLEMS. 

1.     Suppose  a  certain  stove  costs  10  days'  labor  and  a  certain 
302 


CHAPTER  X.    FINAL  PRICE  DETERMINATION 

watch  costs  30  days".     At  what  rate  will  they  exchange? 

2.  Suppose  that  10  pounds  of  raw  cotton  are  produced  in  2 
days,  that  61.63  grains  of  gold  are  produced  in  the  same  time,  and 
that  the  law  defines  a  pound  sterling  as  being  123.27  grains  of 
gold.     How  many  shillings   (there  are  20  in  the  pound)   should 
10  pounds   of   raw  cotton  be  worth? 

3.  Suppose 'that  it  costs   a  half   day's  labor  to  produce  the 
goods  commonly  considered  necessary  to  support  a  laborer  and 
his  family  for  a  day,  that  the  goods  necessary  for  this  purpose 
actually  constitute  a  day's  wages,  that  one-half  day's  labor  will 
produce  25. S  grains  of  gold,  and  that  the  law  makes  25.8  grains 
of  gold  the  standard  fixing  the  value  of  one  dollar.    What  would 
naturally  be  the  money  wages  per  day? 

4.  Starting   with    the   last   problem,   suppose   that   a    laborer 
working  for  a  whole  day  should  produce  for  his  employer,  out 

of   raw   cotton    costing   50  cents,    a   certain    quantity   of    cotton 
yarn. 

(a)  How   much  ought  the  yarn   to  be  worth? 

(b)  How  much  profit  per  day  would  the  employer  naturally 
make  out  of  the  transaction? 

5.  "The  notion  of  Marx  and  the  socialists  generally  that  the 
value  of  a  pair  of  shoes  depends  merely  on  the  amount  of  labor 
expended  on  them  by  the  cobbler  without  respect  to  the  cost  of 
the  leather  in  them,  is  too  ridiculous  for  serious  consideration." 

Show  that  such  language  involves  an  tntire  misapprehension 
of  Marx. 

Refutation  of  the  Labor  Theory — Reading  24. 

A.  In  the  first  place,  as  already  iully  brought  out,  there  are 
noi   a   few   goods   which   have   their    value    determined   with   no 
reference  to  cost  of  any  sort,  labor  cost  or  waiting  cost  or  risk 
cost.     In  this   class  belong  all   rare  unproductive   objects,   those 
producible   objects    whose    possible    output    is    far    short    of    de- 
mand at  prices  much  above  the  corresponding  costs,  and,  most 
of  all,  the  uses  of  land.     In  all  these  cases  marginal  utility  is  of 
course  the  decisive  factor  in   value   determination. 

B.  In  the  second  place,  ordinary  producible  goods,   though 
having    their    values    determined    by    cost    (expense),    yet    have 
them  so  determined  by  a  cost  which  includes  other  things  besides 
labor,  notably  waiting  and  risk.     A  commodity  which  costs  one 
day's  labor  and  ten  years'  waiting  surely  must  and  does  se1!  for 
more  than  another  commodity  which  costs  the  same  amount  of 
labor  but  only  one  year  of  waiting. 

It   would   seem  that  this   second  point   is   too   plain   to   need 
elaboration.     Still,  as  the  matter  is  of  great  practical  moment, 

303 


PRINCIPLES  OF  ECONOMICS 

T  am   disposed  to  make  assurance   doubly   sure  by   making  this 
point   in   the   way  which  has   led   some   of  the   most  prominent 
f    socialists  to  relinquish  the  doctrine. 

I    (1)     In  the  production  of   any  commodity,  there  appear  two 

kinds  of  labor,  previous  labor  spent  on  raw  materials,  tools,  etc., 

/and  current  labor  using  these  materials,  tools,  etc. ; — congealed, 

/stored  up,  labor  and  current  labor.    In  the  outlay  of  the  entre- 

/  preneur,  yiese  two  sorts  of  labor  appear  as  two  kinds  of  capital 

/invested  \  in   them,   viz.,    constant  capital — what   is   paid   for   ma- 

/  terials,  tools,  etc. — and  variable  capital — paid  for  labor-power. 

(2)  If  the  labor  theory  of  value  were  true,  the  entrepreneur 
could  get  a  profit  on  his  variable  capital,  but  on  that  only,  (a) 
He  could  not  get  a  profit  from  the  constant  capital,  since  he 
buys  it  directly  at  the  market  price,  and  its  value,  being  deter- 
mined by  its  labor  cost,  will  be  just  the  same  to  him  as  a  buyer 
as  it  will  be  to  him  when  he  becomes  a  seller.  To  illustrate, 
suppose  that  Mr.  A  is  engaged  in  producing  a  commodity  which 
costs  three  days'  labor,  two  of  previous  labor  spent  on  raw 
materials,  etc.,  and  one  of  current  labor;  and  suppose  that  a  day's 
labor  will  produce  51.6  grains  of  gold,  i.  e.,  $2  of  value.  Then, 
the  value  of  the  completed  commodity  will,  of  course,  be  $6, 
since  it  costs  three  days'  labor.  Further,  it  is  obvious  that  of 
this  value  two-thirds,  $4,  must  be  credited  to  the  prei*ious  labor 
(the  congealed  labor,  the  constant  capital),  since  the  latter  is 
two-thirds  of  the  whole  labor.  But  the  market  value  of  this 
congealed  labor  (materials,  etc.),  must  have  been  $4,  being 
determined  by  a  labor  cost  of  two  days.  It  must,  therefore, 
cost  Mr.  A  $4.  'Thus  he  puts  into  constant  capital  $4  and  gets 
out  of  it  $4.  His  constant  capital,  therefore,  yields  no  profit. 

(b)  'Mr.  A,  could,  however,  get  a  profit  out  of  'his  variable 
capital,  i.  e  ,  the  oortion  spent  on  current  labor.  For,  while  the 
value  said  labor  adds  to  the  raw  materials,  etc.,  is  $2,  its  own 
purchase  price,  the  price  Mr.  A  has  to  pay  for  it,  is  something 
different,  being  determined  by  its  labor  cost,  or  rather  the  labor 
cost  of  the  power  to  furnish  it,  i.  e.,  the  labor  necessary  to  pro- 
duce the  subsistence  of  the  laborer.  If  we  suppose  this  to  be 
one-half  a  day,  then  the  entrepreneur  will  be  able  to  buy  labor 
(labor  power)  for  $1,  and  then  get  out  of  it  a  whole  day's  labor, 
and  therefore  get  out  of  it  value  to  the  amount  of  $2.  Thus, 
from  a  total  expenditure  of  $5,  he  gets  a  commodity  which 
sells  for  $6,  and  so  realizes  a  profit  of  $1.  But  this  dollar,  it  is 

304 


CHAPTER  X.    FINAL  PRICE  DETERMINATION 

plain,  was  entirely  derived  from  his  variable  capital,  the  constant 
portion  having  yielded  nothing. 

(3)  It  is,  however,  quite  impossible  that  a  condition  of  things 
Wiiich  secures  a  large  return  to  variable  capital  and  no  return 
to  constant  capital  should  continue.  In  the  case  above  considered, 
Mr.  A  gets  20  per  cent  on  his  investment.  If  he  had  been  en- 
gaged in  an  industry  requiring  one  unit  of  previous  labor  to 
two  units  of  current  labor,  these  would  have  cost  him  $4,  mak- 
ing his  profit  $2  or  50  per  cent.  If  the  three  days  of  labor  had 
been  one-half  day  of  previous  labor  and  two  and  one-half  days 
of  current,  then  their  cost  would  have  been  $3.50,  making  his 
profit  $2.50  or  70+  per  cent.  On  the  other  hand,  had  the  three 
days'  labor  been  divided  into  two  and  one-half  days  of  past 
and  one-half  day  of  current  labor,  their  cost  would  have  been 
$5.50,  leaving  him  a  profit  of  only  50  cents  or  9  per  cent 

Manifestly  such  a  state  of  things  could  not  continue.  Capi- 
talists would  all  flock  to  the  industries  returning  high  rates,-— 
those  using  much  current  labor,  i.  e.,  much  variable  capital.  As 
a  result,  prices  in  these  industries  would  fall;  while,  in  those 
using  little  current  labor,  i.  e.,  little  variable  capital,  prices 
would  rise.  In  a  word,  prices  would  in  the  one  case  be  lower 
than  labor  cost  would  have  made  them,  and  in  the  other  case 
would  be  higher.  That  is,  exchange  values  would  not  be  deter- 
mined by  labor. 

Note  1.  Some  economists,  more  generous  than  accurate, 
have  declared  that  Marx,  the  socialist  who  is  considered  most 
responsible  for  the  doctrine,  did  not  mean  that  values  are  deter- 
mined by  labor  cost,  but  merely  that  they  ought ^  to  be  so  deter- 
mined. This  entirely  misses  the  point  of  what  is  styled  "Scien- 
tific Socialism."  That  socialism  claims  to  discuss  the  facts  and 
natural  laws  of  the  present  order,  and  to  show  that  the  unhinr 
dered  working  of  those  laws  brings  about  certain  undesirable 
results.  Its  whole  argument  is  pointless  save  on  the  assumptiojn 
that  it  is  dealing  with  actual  principles.  If  values  are  not  here 
and  now  determined  by  labor  cost,  the  whole  proof  that  capital 
gets  a  surplus  actually  produced  by  labor  falls  to  the  ground.  ; 
Further,  such  an  interpretation  of  Marx  must  ignore  his  ovvn 
explicit  statements.  Thus,  he  says:  "We  see,  then,  that  th^t 
which  determines  the  magnitude  of  the  value  of  any  article  is 
the  amount  of  labor  socially  necessary,  or  the  labor  time  socially 
necessary  for  its  production."  Chap.  I,  Sect.  11;  or  again:  "Th« 
price,  then,  is  merely  the  money-name  of  the  quantity  of  social 
labor  realized  in  his  commodity."  Chap.  Ill,  Sect.  2;  or  again: 
"We  know  that  the  value  of  each  commodity  is  determined  by  the 
quantity  of  labor  expended  on  and  materialized  in  it  by  the 

305 


PRINCIPLES  OF  ECONOMICS 

working-time  necessary,  under  given  social  conditions,  for  its 
production."  Chap.  VII,  Sect.  2. 

Still  further  to  refute  this  notion  that  socialists  do  not  reall} 
teach  the  labor  theory,  we  have  the  fact  that  the  most  recent 
expositions  of  their  ideas  contain  the  old  doctrine.  Thus  in  1900 
John  Spargo,  a  prominent  socialist  lecturer,  wrote  a  book  on 
socialism  in  which  we  find  these  words :  "The  exchange  value 
of  commodities  4S  determined  by  the  amount  of  average  labor  at 
the  time  socially  necessary  for  their  production."  p.  196.  Further, 
Spargo  quotes  with  hearty  endorsement  a  two-page  exposition 
of  Marx's  Surplus  Value  theory  of  profits  by  another  socialist, 
Algernon  Lee,  in  which  exposition  the  labor  theory  of  value  is 
made  to  play  the  same  role  as  in  the  original  presentation  by 
Marx. 

Note  2.  The  student  must  not  imagine  that  socialism  as  a 
project  of  reform  stands  or  falls  with  the  labor  theory  of  value. 
The  movement  has  not  a  few  able  advocates  who  frankly  re- 
pudiate the  Marxian  economics.  Socialism  is  essentially  a  scheme 
of  soc:al  organization  for  economic  ends.  As  such  a  scheme,  it 
deserves  to  be  considered  on  its  own  merits,  without  respect  to 
the  entirely  untenable  doctrines  with  respect  to  the  present  order 
which  its  advocate*  have  commonly  held.  Nevertheless,  there 
cnn  be  no  doubt  that  the  general  rejection  of  Marxian  eco- 
nomics, which  must  surely  come,  will  weaken  the  socialist  move- 
ment. For,  as  already  noted,  the  strength  of  the  movement  has 
depended,  in  large  measure,  on  grossly  exaggerated  statements 
as  to  the  unreasonableness  and  injustice  of  the  present  order, 
and  these  statements  have  been  founded  on  the  labor  theory  of 
value. 


306 


CHAPTER  XL 

• 

SOME  SPECIAL  CASES  OF  PRODUCTION. 

Almost  at  the  beginning  of  our  study,  in  Chapter  II,  we 
discussed  the  true  nature  of  production  as  understood  by  the 
economist.  At  that  time  we  emphasized  strongly  the  breadth 
of  the  concept,  showing  that  every  act  tending  to  increase  util- 
ities, if  done  in  response  to  an  economic  motive,  is  a  productive 
act.  Putting  the  matter  in  slightly  altered  shape,  it  was  said 
that  every  act  which  overcomes  any  one  or  more  of  the  many 
obstacles  which  lie  between  our  wants  and  their  gratification  is 
necessarily  a  productive  act.  Still  again,  changing  slightly  our 
statement  of  the  matter,  it  may  be  said  that  every  sort  of  action 
which  plays  a  part,  performs  a  function,  in  the  working  of  the 
present  economic  order,  is  truly  productive.  These  considera- 
tions would  seem  to  furnish  adequate  criteria  in  deciding  whether 
or  not  any  particular  activity  is  productive.  We  have  only  to 
settle  whether  that  activity  increases  utilities  or  removes  some 
obstacle  to  our  gratifications  or  performs  some  function  in  th*? 
general  economic  order.  Further,  the  application  of  these  or 
similar  criteria  would  seem  to  be  sufficiently  easy  to  render  need- 
less any  further  discussion  of  this  matter.  In  fact,  however,  it 
is  not  always  the-  simplest  matter  in  the  world  to  discover  just 
what  function  a  particular  activity  performs ;  and,  anyhow,  com- 
mon opinion  has  so  long  doubted  or  denied  the  productivity  of 
certain  lines  of  business  that  some  special  discussion  of  these 
particular  cases  seem  almost  necessary  at  some  stage  of  our 
study  of  elementary  economics.  The  present  connection  may  he 
taken  as  furnishing  a  fairly  satisfactory  opportunity  for  attend- 
ing to  this  task. 

Section  A.     Insurance — Is  It  Productive?    Has  It  a  Real 

Economic  Function? 

A  discussion  of  this  question  is  doubtless  less  necessary  than 
a  generation  or  two  ago  when  not  a  few  persons  looked  on  this 
business  as  little  removed  from  gambling.  Even  now,,  however 
many  persons  who  consider  insurance  quite  legitimate  would 

307 


PRINCIPLES  OF  ECONOMICS 

hesitai-e  to  cal1  it  productive.  There  is  no  ground  for  such  hes- 
itation. Every  business  which  furnishes  a  service  of  any  sortr 
which  performs  any  function  called  for  in  the  economic  order, 
is  productive.  And  insurance  certainly  performs  such  a  function. 
That  function  is  to  provide  for  the  bearing  of  the  risk  burden 
characteristic  of  economic  relations  in  such  a  way  that  that  bur- 
den will  be  most  easily  borne,  will  work  least  economic  injury. 
If  insurance  does  this,  it  surely  creates  utilities,  performs  serv- 
ices. That  such  is  the  work  it  accomplishes  is  easily  shown.  The 
essence  of  insurance  is  the  pooling,  putting  into  one  mass,  of  a 
large  number  of  risks,  in  other  words,  acting  as  one  person  in 
the  bearing  of  risks.  By  doing  this  we  substitute  a  series  of 
certain  smalt  losses  for  a  chance  of  a  great  loss.  To  illustrate,, 
suppose  we  take  1,000  houses,  owned  by  1,000  persons,  each 
house  worth  $2,000.  To  each  owner  the  burning  of  his  house 
would  mean  a  loss  of  $2,000;  and,  since  nothing  can  be  known 
in  advance  as  to  the  likelihood  of  its  burning,  each  owner's  con- 
stant risk  equals  $2,000,  the  entire  value  of  his  house,  one  hun- 
dred per  cent.  But,  if  all  these  houses  be  taken  together,  the 
case  is  very  different.  From  statistics  as  to  the  past  working  of 
things  we  can  be  sure  that,  say,  three  but  not  more  than  three 
out  of  the  thousand  houses  will  burn  each  year,  and  so  that  the 
total  risk  on  the  houses,  the  risk  on  the  whole  number  taken 
together,  is  only  $6,000  per  year  on  a  total  value  of  $2,000,000. 
Distributed  over  1,000  owners  this  means  a  payment  of  $6  per 
year.  Thus  by  making  small  payments  every  year  a  man  may 
get  rid  altogether  of  the  risk  of  losing  $2,000.  This  surely  is  a 
profitable  transaction.  A  real  utility  has  been  created.  The 
probable  efficiency  of  industry  has  been  enhanced ;  since  the 
injury  or  burden  to  industry  as  a  whole  due  to  the  collecting  of 
a  series  of  small  anticipated  payments  from  all  owners  is  vastly 
less  than  that  which  would  result  from  an  unexpected  loss  of 
$2,000  falling  on  each  of  three  persons  each  year.  The  operation 
is  therefore  productive. 

Note:  This  making  a  regularly  recurring  payment  to  avoid 
the  chance  of  a  great  loss  is  in  no  sense  gambling.  Gambling  is 
the  assumption  of  needless  risk.  Here  the  risk  is  unavoidable. 

The  preceding  discussion  has  justified  only  mutual  insurance, 
insurance  wrhere  the  insured  co-operate.  Is  the  case  of  Specu- 
lative insurance — company  insurance — good?  Surely,  yes.  There 
is  no  essential  difference  between  the  two  cases  All  insurance 

308 


CHAPTER  XL  CASES  OF  PRODUCTION. 

Is  mutual,  i.  e.,  it  is  only  through  the  pooling  of  the  risks  of 
many  owners  that  insurance  is  possible.  The  real  program,  the 
general  plan,  is  the  same  in  both  co-operative  and  company  in- 
surance. The  only  difference  is  in  the  process  of  carrying  out 
the  program.  On  the  co-operative  plan,  the  insured  themselves 
undertake  to  effect  and  manage  their  mutual  insurance.  On  the 
company  plan,  an  outside  body  undertakes  this  job,  i.  e.,  the 
effecting  and  managing  of  the  mutual  insurance.  In  doing  this, 
the  company  obviously  furnishes  a  service  additional  to  that  of 
mere  mutual  insurance,  i.  e.,  it  performs  the  regular  entre- 
preneur function  and  so  in  a  twofold  sense  produces  wealth. 

ILLUSTRATIVE  PROBLEMS. 

1.  Suppose  1,000  owners  of  1,000  buildings  worth  each  $7,OOG 
wish  to  insure  themselves  against  fire.     If  the  risk  for  the  class 
of  buildings  involved  is  such  that  7  out  of  1,000  burn  down  each 
yeajr,  what  annual  payment  from  each  owner  would  be  necessary 
to  insure  all  against  total  loss, — expenses  of  management,  inter- 
est, etc.,  being  ignored? 

2.  Suppose  1,000  persons  propose  each  to  save  for  his  fam- 
ily before  his   death.  $2,000.    All  are  twenty-five  years   of  age. 
Knowing  that  anyone  is  liable -to  die  before  he  has  had  time  to 
save  so  much,  they  combine  to  insure  one  another  that  $2,000 
shall  be  ready  for  the  family  even  if  death  comes  before  that 
sum  has  been  regularly  accumulated.     Assuming  that  the  organ- 
ization  is   continuous,   new   members  joining  as   old   ones   pass 
away,  and,  assuming  the  average  annual  death  rate  to  be  18  in 
1,000,  what   annual   payment  would   each   one   need   to   make,— 
expenses  of  management,  interest,  etc.,  being  ignored? 

3.  Suppose   that   a    certain   corporation   owns    500  buildings 
worth    each    $100,000;    that   to   insure    in    an    ordinary  company 
would  cost  the  corporation  $250  a  year  on  each  building;   and 
that    the   corporation   is   convinced    that   by   the    expenditure   of 
$10,000  the  fire  loss  can  be  reduced  to  an  average  of  one  build- 
ing  every   three   years.     Under   these   conditions,    would    it   pay 
the  corporation  to  insure  with  some  company?     Prove. 

Section  B.     Speculative  Trading — Is  It  Productive?  Has  It  an 
Economic  Function? 

Here,  as  IP  the  case  of  insurance,  the  answer  is  affirmative, 
though  in  this  case  not  without  qualification.  Much  which  passes 
for  speculation  is  gambling  pure  and  simple;  much  more,  though 
legitimate  in  form,  is  in  spirit  nothing  different  from  gambling. 

309 


PRINCIPLES  OF  ECONOMICS 

I.     Produce  Speculative  Trading. 

(1)^    The  nature  of  Speculation. 

To  speculate  is  to  deal  in  goods  with  purpose  of  gaining  a 
profit  from  price  changes  in  the  same  market.  In  this  it  con- 
trasts with  mercantile  trading  which  seeks  profit  from  price 
differences  in  different  markets  forming  members  of  a  series. 

Illustration :  When  a  dealer  on  the  Chicago  wheat  market 
agrees  in  December  to  deliver  wheat  in  May,  believing  that  he 
will  be  able  to  buy  it  at  a  lower  price  than  the  one  agreed  upon, 
he  is  speculating.  When  the  same  man  buys  wheat  on  the  same 
exchange  and  sells  it  to  a  miller  in  Rochester,  he  is  engaged  in 
the  regular  trade.  Of  course  he  makes  a  profit,  but  that  profit 
is  due  to  the  difference  of  price  between  the  wholesale  market 
and  the  miller's  market. 

(2)  Speculative    Markets,    Exchanges,     Boards     of    Trade, 
Bourses. 

The  most  thoroughgoing  forms  of  speculation  are  carried  on 
in  special  markets,  called  by  various  names,  of  which  the  wheat, 
cotton,  and  stock  exchanges  are  the  most  conspicuous  examples. 
Some  of  the  more  notable  characteristics  of  these  exchanges  are 
the  following: 

(a)  Trading  in  common ;  all  dealers  in  the  involved  com- 
modity coming  together  in  a  complex  of  buying  and  selling. 
(b)  Open  trading;  no  privacy  as  respects  other  traders,  bar- 
gains known  to  all  in  respect  to  prices,  amounts,  etc.  (c)  Trad- 
ing through  official  dealers,  brokers,  (d)  Large  scale  dealing 
(e)  Major  part  of  trading,  speculative,  (f)  In  produce  mar- 
kets, trading  in  futures  usually  present. 

(3)  Chief  Functions  of  Speculation. 

(A)  To  establish  proper  price.  (B)  To  secure  the  bearing 
of  the  risk  burden  of  ownership  in  the  easiest  and  cheapest  way. 

(4)  Function  A  Considered. 

(a)  As    already    strongly    emphasized,    the    securing    of   the 
proper  price,  i.  e.,  the  price  which  is  demanded  by  the  real  con- 
ditions  of  output  and   need,   is   a   matter   of   great   importance; 
since  it  is  chiefly  through  price  that  the  automatic  regulation  of 
economic  action  is  effected. 

(b)  Free  speculation,  with  ample  competition  on  both  sides 
of  the  market,  is  the  natural  way  to  secure  the  proper  price,  the 
price  which   ought  to   prevail   in   view   of  the  real  condition   of 
need   and   output. 

Caution :      It    must    be    admitted    that,    in    the    present    con- 

310 


CHAPTER   XI.     CASES    OF   PRODUCTION. 

dition  of  speculative  trading  when  public  control  is  undeveloped 
and  the  standards  of  business  morality  are  very  low,  true 
speculation  is  often  mingled  with  many  forms  of  dishonest 
manipulation  which  more  or  less  hinder  the  establishment  of 
proper  prices.  Commonly,  however,  these  influences  are  very 
short-lived  ;  in  the  long  run  the  real,  underlying  forces  regulate 
the  market. 

(5)     Function  B  Considered. 

(a)  All  ownership  of  property  involves  the  risk  of  loss  from 
changes  in  value.    The  miller  who,  in  December,  buys  wheat  that 
will   not  be   marketed  as   flour   till    April    runs    the  chance   that 
wheat  and  flour  will  both   fall  in   price  between  the  twro   dates, 
and  so  he  will  have  to  write  off  a  loss. 

(b)  Speculative   trading    permits    the    transferring    ot    this 
burden  from  ordinary  owners,  e.  g.,  millers,  to  a  special  class. 

Illustration :  A  milling  company  buys  10,000  bu.  of  wheat  on 
the  Chicago  exchange,  said  wheat  to  be  delivered  at  once  for  use 
in  the  milling  business.  But  the  milling  company  wishes  to  con- . 
fine  itself  strictly  to  its  own  business — mi'ling — avoiding  all  spec- 
ulation in  wheat.  It  therefore  wishes  to  shut  out  any  chance 
c"  Hss  by  a  fall  in  the  price  of  whear  and  flour  between  the 
purchase  of  the  whe"at  and  the  sale  of  the  flour  made  from  it. 
Accordingly,  it  sells  10,000  bu.  for  future  delivery;  i.e.,  agrees 
to  deliver  10,000  bu.  at  a  definite  price  three  months  from  date. 
This  having  been  done,  whatever  change  takes  place  in  the  price 
of  wheat,  the  milling  company  will  neither  gain  nor  lose ;  that  is, 
whatever  it  gains  or  loses  on  the  original  purchase  of  cash  wheat 
will  be  exactly  offset  by  an  equal  loss  or  gain  on  the  future  sale. 

Thus,  suppose  that,  when  the  purchase  is  made,  cash  wheat 
is  $1.00  per  bu.  and  three-months  futures  $1.04.  Further  sup- 
pose that,  when  the  three  months  have  passed,  wheat  is  $1.04. 
Under  these  conditions  the  two  transactions  will  come  out  as 
follows : 

CASH    WHEAT.  FUTURE. 

Original  cost.. $10,000    Cost  $10,400 

Storage,  insurance,  etc.       400 

Total   cost $10,400 

Value    10,400     Selling  value 10.400 

Gain  or  loss $00,000       Gain  or  loss $00,000 

Evidently  in  this  case  there  is  neither  gain  nor  loss  from  the 
transactions. 

311 


PRINCIPLES  OF  ECONOMICS 

Suppose,  now,  that  the  price  at  the  time  of   future  delivery 
turns  out  to  be  $1.00;  will  the  result  be  different? 

CASH   WHEAT.  FUTURE. 

Total   cost $10,400         Cost    $10,000 

Value    10,000        Selling  value 10,400 


Loss $      400         Gain   $      400 

Still  again,  suppose  price  to  be  poc  at  time  of  future  delivery; 
what  result? 

CASH    WHEAT.  FUTURE. 

Total   cost $10,400        Cost  $  9,000 

Value    9,000        Selling  value 10,400 


Loss    $  1,400        Gain     $  1,400 

Finally,  suppose  price  at  time  of  future  delivery  to  be  $1.10; 
what  result? 

CASH   WHEAT.  FUTURE. 

Total  cost $10,400        Cost    $11.000 

Value    11,000        Selling  value 10,400 

Gain   $     600        Loss    $     600 

Thus  on  any  price  the  element  of  risk  from  price  changes 
is  eliminated. 

ILLUSTRATIVE  PROBLEMS. 

A  Liverpool  miller  buys  through  a  Duluth  commission  house 
50,000  Bushels  of  wheat,  paying  93  cents  a  bushel,  and  at  the 
same  time  sells  30,000  bushels  for  May  delivery,  the  price  being 
$5l/2  cents. 

(a)  Assuming  that  2l/2   cents   covers  the  cost,    (storage,  in- 
surance,   and    interest)    of    carrying    the    wheat    from    the    date 
of   purchase   till    May,   show   that   the    miller    will   lose   nothing 
on  the  wheat  even  if  by  May  the  price  should  fall  to  70  cents. 

(b)  Would  he  gain  if  the  price  should  rise  to  $1.10?    Prove. - 

(c)  What  did  the  word  "carrying"  in  the  second  sentence  of 
the  problem  mean? 

II.     Speculative  Trading  in  Stocks  and  Bonds. 
Besides  the  speculation  in  produce  just  considered,  there  is, 
of  course,  speculative  trading  in  stocks  and  bonds,  i.   e.,  in  the 
shares  of  corporations  and  the  notes  which  they  have  given  to 

312 


CHAPTER   XL     CASES    OF   PRODUCTION. 

capitalists  in  exchange  for  loans.  The  markets  where  such 
trading  is  carried  on  are  known  as  Stock  Markets.  They  are 
conducted  like  wheat  exchanges,  with  open  trading,  abundant 
competition  on  both  sides,  speculative  trading,  etc.  Much  that 
is  to  be  condemned  appears  in  their  conduct.  But  they  are 
after  all  productive  institutions.  They  play  useful,  almost  indis- 
pensable, roles  in  the  economic  order.  Their  most  important 
function  is  to  render  more  efficient  the  capital  of  the  country. 

(a)  They  make  investment  easy. 

(b)  They  make   withdrawal   from   an   investment  easy,  and, 
in  so  doing,  make  capitalists  more  disposed  to  invest. 

(c)  They    bring   together    all    classes    of    investments,    make 
clear   their   disadvantages,  and    so   appeal   to   all   classes   of  in- 
vestors,  e.   g.,   those   who    wish   above   all   security;   those  who 
demand   a  chance    for  large   returns;    those   who   can   wait    in- 
definitely for  returns  of  any  sort;  etc. 

(d)  They    make    the    properties    represented    in    stocks    and 
bonds   perfectly    available    as    a   basis    for   loans.      (Banks    will 
readily   accept  such   bonds   and   stocks   as   security,    seeing  that 
there  is  a  continuous  and  unlimited  market  where  these  prop- 
erties can  be  disposed  of  at  almost  any  moment.) 

(e)  It  is  worth  noting  that  the  stock  market  furnishes  gov- 
ernment with  the  best  available  clue  to  the  value  of  corporate 
properties  when  these  are  needed  for  the  purposes  of  taxation  or 
social  control. 


313 


CHAPTER  XII. 

SOME  OF  THE  MORE  IMPORTANT  PRINCIPLES 
GOVERNING  FONEY. 

Thus  far  we  have  done  nothing  with  the  complicated  and 
difficult  subject  of  money  except  to  set  forth  in  Chapter  VII  some 
simple  truths  which  seem  almost  too  obvious  to  deserve  formal 
statement.  Now,  however,  we  have  reached  a  point  where  it 
seems  necessary  and  proper  to  present  the  more  essential  among 
the  real  principles  of  the  subject,  though  even  now  anything  like 
an  exhaustive  study  of  this  matter  is  out  of  the  question. 

Section  A. — Principles  Governing  the  Money  Standard. 

The  student  will  remember  that  the  monetary  standard  is  that 
something  which  fixes  the  significance  or  value  of  the  money 
unit ;  e.  g.,  in  the  United  States  25.8  grains  of  gold,  nine-tenths 
fine,  fixes,  regulates,  the  value  of  the  dollar.  Whatever  value 
25.8  grains  of  gold  may  have  at  any  time,  that  same  value  will  be 
had  by  one  dollar.  This  account  of  the  monetary  standard  very 
plainly  shows  that  it  is  in  a  very  important  sense  the  foundation 
of  the  whole  system.  Further,  experience  shows  that  it  is  by  no 
means  easy  for  a  nation  to  get  or  keep  the  standard  it  wishes  to. 
Again  and  again  nations  have  unintentionally  done  something 
which  ousted  the  standard  they  had  had,  and  suddenly  put  them 
on  a  new  one.  It  is  therefore  of  much  importance  to  know 
the  natural  laws  which  regulate  the  standard. 

These  principles  may  be  grouped  in  two  classes:  (l)  those 
which  define  and  determine  standard  money;  i.  e.,  the  immediate 
standard,  the  something  which  directly  fixes  the  value  of  the 
unit,  and  (2)  those  which  define  and  determine  the  ultimate 
standard;  i.  e.,  the  something  which  finally  fixes  the  value  of 
standard  money  itself.  Thus,  gold  coin  is  our  standard  money, 
since  one  dollar — the  unit — follows  gold  coin  ;  but  25.8  grains  of 
gold  bullion  is  our  ultimate  standard,  in  that  gold  coin  itself 
follows  this  25.8  grains  of  gold  bullion. 

Principle  1.      The  standard  money  of  any  system  must  be  a 
314 


CHAPTER  XII.     PRINCIPLE'S   OF  MONEY 

money  which  is  at  par  and  which  has  its  value  -fixed  independently 
of  its  relations  to  other  moneys. 

Argument.  (1)  Standard  money  must  be  at  par.  By  defini- 
tion, standard  money  immediately  fixes  the  value  of  the  unit. 
But,  obviously,  no  money  which  has  a  value  above  or  below  the 
unit  can  fix  the  value  of  the  unit.  (2)  If  a  particular  money 
has  its  value  fixed  by  its  relation  to  some  other,  e.  g.,  a  treasury 
note  kept  at  par  with  gold  by  being  redeemed  in  gold,  then  such 
money  is  obviously  one  of  the  things  which  is  determined  rather 
than  the  thing  which  determines. 

ILLUSTRATIVE  PROBLEMS. 

1.  In  the  United  States  in  1870,  gold  cpin  was  worth  $1.21 
per  dollar,  silver  coin  $1.23  per  dollar,  and  greenbacks  $1.00  per 
dollar.     Which,  if  any,  must  have  been  standard  money? 

2.  For  several  weeks  during  the  panic  of  1837  coined  money, 
whether  silver  or  gold,  was  at  a  premium  of  from  2  to  4  per 
cent,  while  bank  notes  were  at  par.     Which,  if  any,  must  have 
been  standard  money? 

3.  Add  to  the  first  problem  that  in  1870  national  bank  notes 
were  worth  $1.00  per  dollar  and  were  redeemable  in  greenbacks. 
Which  money,  under  this  condition,   must   have   been   standard 


Principle  II.  If,  among  those  moneys  in  any  system  which 
are  a  valid  tender  in  the  payment  of  debts,  differences  of  ex- 
change value  arise,  the  cheapest  of  such  valid  tender  moneys 
establishes  itself  as  the  standard  money,  and  the  rest  go  to  a 
premium. 

Illustration. — In  the  first  problem  under  Principle  I  we  have 
three  moneys  all  legal  tender  and  each  different  from  the  others 
in  value; — the  cheapest  being  worth  21  cents  less  than  the  next 
higher  and  23  cents  less  than  the  highest.  Under  tihese  condi- 
tions, the  cheapest,  greenbacks,  became  the  standard  money,  gold 
and  silver  going  to  premiums  of  21  and  23  cents  respectively. 

Argument.  (1)  As  long  as  all  the  moneys  in  question  are 
valid  tenders  for  debts,  debtors  will  choose  the  cheapest  for  this 
purpose,  thus  making  that  money  the  standard  money  for  debts. 

(2)  For  the  sake  of  business  convenience,  the  standard  money 
of  debts  and  that  of  prices  are  bound  to  be  the  same,  if  possible. 

(3)  This  is  perfectly  possible;  since,  though  the  standard  money 
of  debts  is  fixed  as  in  (1),  that  of  prices  is  free  to  move      (4) 
Accordingly,  the  standard  money  of  prices  will  adjust  itself  to 

315 


PRINCIPLES  OF  ECONOMICS 

that  of  debts,  i.  e.,  to  the  cheapest  of  the  valid  legal  tenders,  thus 
making  the  latter  the  standard  money  in  general. 

Corollary  1.  //  two  metallic  moneys  are  freely  coined  and 
full  legal  tender  at  a  coinage  ratio  different  from  the  market 
ratio,  the  money  coined  from  the  overrated  metal  will  establish 
itself  as  the  standard  money. 

Argument.  Suppose  that  when  1  ounce  of  gold  is  on  the 
market  worth  16  ounces  of  silver,  the  mint  treats  1  ounce  of  gold 
as  worth  only  15  ounces  of  silver,  putting  into  each  silver  coin 
less  metal'  than  is  needed,  considering  their  market  ratio.  Under 
these  conditions,  each  silver  coin  will  be  worth  less  than  the 
corresponding  gold  coin,  and  so,  by  Principle  II,  will  make  itself 
standard  money.  But,  when  the  mint  thus  treats  silver  as  worth 
more  than  it  really  is,  the  mint  is  said  to  overrate  silver.  Hence, 
the  corollary  that  the  money  made  from  the  overrated  metal  will 
establish  itself  as  the  standard  money. 

Corollary  2.  //,  in  the  case  of  a  legal  tender  circulating  note 
which  has  hitherto  been  kept  redeemable  in  what  has  hitherto 
been  standard  money,  a  suspension  of  payments  takes  place,  such 
legal  tender  note  will  almost  certainly  establish  itself  as  standard 
money. 

Argument. — Such  a  circulating  note  is  a  mere  promise  to  pay 
what  has  been  hitherto  standard  money.  When  the  issuer  sus- 
pends payment  on  his  promise,  its  value  inevitably  falls  off. 
People  expect  he  will  pay  some  time  but  are  not  willing  to  give 
as  much  for  a  probable  future  payment  as  for  a  certain  present 
one.  But,  when  the  note  becomes  worth  less  than  former  stand- 
ard money,  it  inevitably  displaces  such  money  under  the  opera- 
tion of  Principle  II. 

ILLUSTRATIVE  PROBLEMS. 

1.  In  the  United  States  in  1830,  both  gold  and  silver  were 
freely  coined  at  a  ratio  of  15  to  1,  when  the  market  ratio  was 
15.8  to  1. 

(a)  Which  metal  did  the  mint  overrate?     Explain  carefully. 

(b)  Which  of  the  two  moneys,  if  any,  must  have  been  stand- 
ard money? 

2.  In  1830  France  had  a  system  similar  to  ours  but  its  ratio 
was  15.5  to  1. 

Answer  the  same  questions  for  it,  as  for  the  United  States 
under  1. 

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CHAPTER  XII.     PRINCIPLES   OF  MONEY 

3.  Why    did    the   United    States   have   the   greenback   as   its 
standard  money  between  1862  and  1879? 

4.  In  1717  the  British  government  decreed  that  a  gold  guinea 
should  be  treated  as  the  equivalent  of  21  silver  shillings ;  though, 
judged    by    the    bullion    in    them,    the    guinea    was    worth    2Ql/2 
shillings.     Which  must  have  become  standard  money?      Explain. 

5.  In  the.  panic  weeks  of  1837,  bank  notes  were  the  standard 
money.     (See  Problem  2,  page  315.)    How  do  you  explain  it? 

je 
The    preceding    discussion    has    concerned    the    defining    and 

determining  of  standard  money.  We  now  bring  out  two  prin- 
ciples which  have  to  do  with  defining  and  determining  the 
ultimate  standard. 

Principle  III.  If  by  any  process  -whatsoever  the  standard 
money  is  kept  constantly  equal  in  value  to  a  definite  qitantity  of 
sonic  outside  Commodity  or  group  of  commodities,  such  com- 
modity or  group  of  commodities  constitutes  the  ultimate  standara 
of  the  system. 

Illustration.     If  a  country  should  issue  only  paper  money,  but 

should  at  all  times  redeem  such  money  in  gold  bullion  at  the 
rate  of  25.8  grains  for  each  dollar,  and,  on  the  other  hand,  should, 

when  it  was  desired,  pay  out  one  dollar  in  money  for  every  25. & 

grains  of  bullion  brought  in,  then  the  ultimate  standard  would 

be  25.8  grains  of  gold;  for  25.8  grains  of  gold  would  fix  the  value 
of  one  dollar. 

Argument.  The  principle  scarcely  seems  to  require  proof. 
The  condition  stated  in  the  theorem  ties  together  in  value  the 
two  things, — standard  money  and  a  certain  quantity  of  some 
outside  thing,  say  a  lump  of  gold  weighing  25.8  grains.  But,  oi 
these  two  things,  one  is  plainly  more  stable,  fixed,  than  the 
other;  the  value  of  the  lump  of  gold  can  change  only  as  all  the 
gold  on  the  general  market  of  the  world  changes,  while  the 
value  of  the  standard  money  of  one  out  of  many  countries  might 

change  without  affecting  anything  but  itself.  We  must,  there- 
fore, think  of  the  metal  as  fixing  the  value  of  the  money  rather 

than  the  reverse. 

ILLUSTRATIVE  PROBLEMS. 

1.  A  few  years  ago,  the  United  States  remodeled  the  mone- 
tary system  of  the  Philippines,  making  silver  pesos  coined  only 
for  the  government  the  standard  money,  but  providing  that  gold 
exchange  on  New  York  should  be  sold  to  any  person  wanting  it 
in  exchange  for  silver  pesos  at  a  rate  of  $1  for  two  pesos.  Such 

317 


PRINCIPLES  OF  ECONOMICS 

a  system  tended  to  establish  what  ultimate  money  standard  in 
the  Philippines? 

2.  Great  Britain  puts  into  every  sovereign  113  grains  of  pure 
gold,  coins  these  sovereigns  for  every  one  free  of  charge,  and 
does  not  attempt  to  hinder  the  melting  of  coins.  Under  these 
conditions  what  necessarily  becomes  the  ultimate  money  standard 
of  Great  Britain?  Explain  fully. 

3.  What  must  have  been  the  ultimate  standard  of  the  United 
States  in  1830?     See  Problem  i,  page  316. 

4.  What  must  have  been  the  ultimate  standard  of  France  at 
the  same  date?      See  Problem  2,  same  page. 

Principle  IV.  //-'  the  standard  money  is  not  kept  constantly 
equal  in  value  to  a  fixed  quantity  of  sonic  commodity  or  grout) 
of  commodities  outside  itself,  but  varies  in  value  independently 
o/  the  variations  of  any  other  object,  then  such  standard  money 
is  itself  the  ultimate  standard  of  the  system. 

Illustration.  Prior  to  1893  British  India  had  as  its  ultimate 
money  standard  180  grains  of  silver;  i.  e.,  the  unit  coin,  a  rupee, 
contained  180  grains  of  silver  and  was  freely  coined,  thus  making 
the  metal  itself  the  ultimate  determinant  of  the  value  of  the 
rupee.  But,  in  the  year  named,  the  government  stopped  the  free 
coinage  of  silver  with  the  result  that  coins  rose  in  value  as  com- 
pared with  the  metal  in  them,  fluctuating  from  32  cents  down 
towards,  but  never  to,  their  bullion  value,  22  cents.  Thus  the 
silver  rupee  had  nothing  behind  it  to  fix  its  value — it  moved  up 
and  down  independently  of  anything  else.  Accordingly,  the 
silver  rupee  fixed  the  value  of  the  unit  (the  rupee)  not  only 
immediately  but  also  ultimately ;  and  hence  was  itself  the  ultimate 
Standard.  (This  illustration  would  seem  to  furnish  sufficient 
proof  of  the  principle.) 

ILLUSTRATIVE  PROBLEMS. 

1.  What  was  the  ultimate  standard  of  the  United  States 
between  1862  and  1879?  Explain. 

2.  What  was  the  ultimate  standard  of  the  United  States  dur- 
ing the  panic  weeks  of  1837?     See  Problem  2,  page  315. 

3.  Suppose,  that  after  1893  the  government  of  British  India 
had   so   managed  things  as   to  keep  gold    exchange   on   London 

constantly  at  20  rupees  for  1  sovereign  (123.27  grains  of  gold). 
What  would  then  have  been  practically  the  ultimate  standard  of 
India? 

318 


CHAPTER  XII.     PRINCIPLES   OF  MONEY 

Section  B.    Circulation  of  Money. 

The  second  group  of  monetary  principles  which  we  must 
study  concern  the  circulation  of  money.  Will  a  particular  money 
circulate  at  all?  What  kinds  of  money  have  greater  tenacity  in 
circulation?  To  what  part  of  the  circulation  is  a  particular  kind 
of  money  likely  to  gravitate?  and  so  on.  These  and  other 
related  questions  are  of  importance  because  of  the  fact  that  in 
the  course  of  events  governments  have  occasion  to  arrange  mat- 
ters so  as  to  keep  a  particular  money  in  circulation;  or  in 
another  case  so  as  to  drive  a  particular  money  out  of  circulation ; 
or  in  still  another  so  as  to  keep  a  particular  kind  of  money  down 
to  a  small  stock,  though  not  driving  it  out  altogether;  or  again, 
so  as  to  segregate  a  particular  kind  of  money  in  some  special 
part  of  the  system;  and  so  on.  The  natural  laws  regulating 
these  matters  are  fairly  numerous ;  but  here  we  can  bring  for- 
ward only  two  or  three  of  the  most  important. 

Principle  V.  Broadly  speaking,  a  money's  tenacity  in  circula- 
tion varies  directly  as*  its  capacity  to  do  the  various  kinds  of 
money  ivork  and  the  degree  to  which  that  capacity  is  assured. 

Illustrations.  A  money  which  is  receivable  by  government  in 
payment  of  taxes  has  more  tenacity  in  circulation  than  a  similar 
money  which  is  not  so  receivable.  A  money  which  is  a  legal 
tender  in  most  relations  circulates  more  surely  than  one  which 
is  not.  Bank  notes  which  can  be  used  as  bank  reserves  by  state 
banks  have  more  tenacity  in  circulation  than  notes  which  can  not 
be  so  used. 

Principle  VI.  In  the  case  of  credit  money,  tenacity  in  circu- 
lation varies  directly  as  the  difficulty  of  returning  such  money 
to  the  issuer. 

Illustration.  If,  in  order  to  get  a  bank  note  redeemed,  the 
holder  is  obliged  to  send  it  to  some  city  hundreds  of  miles 
distant,  paying  the  cost  himself,  he  is  likely  to  give  up  the  idea 
altogether  and  content  himself  with  passing  the  note  on  in 
buying  goods  or  paying  debts.  Thus,  such  notes  tend  to  con- 
tinue in  circulation,  rather  than  going  out  by  return  to  the  issuer. 
Reversing  the  conditions  would,  of  course,  reverse  the  tendency 

Argument.      The  principle  probably  needs  no  other  argument 


*Remember  that  in  Economics  "to  vary  directly  as"  means  only  to  vary 
in  the  same  direction,  not  proportionally;  and  to  "very  inversely  as"  means 
only  to  vary  in  the  opposite  direction,  not  proportionally. 


PRINCIPLES  OF  ECONOMICS 

than  to  make  clear  that  returning  to  the  issuer  does  actually  put 
a  credit  money  out  of  circulation ;  since,  assuming  this  to  be 
true,  it  is  obvious  that  any  obstacle  to  such  returning  would 
strengthen  the  hold  of  said  money  on  the  circulation,  while  the 
removal  of  that  obstacle  would  weaken  its  hold.  There  are 
various  ways  of  showing  that  a  circulating  note  is  retired  by 
return  to  the  issuer;  but  for  our  own  present  needs  the  simplesf 
will  answer.  When  a  note  has  been  returned  to  the  issuer,  the 
situation  is  precisely  what  it  was  before  said  note  had  been 
issued  at  all.  But,  of  course,  a  note  can  not  be  said  to  be  in 
circulation  before  it  has  been  issued  at  all.  Hence  it  can  not  be 
said  to  be  in  circulation  after  return  to  the  issuer. 

Principle  VII.  (Grcsham's  Law'.}  Comparing  (i)  moneys 
•which  have  more  value  in  circulation  than  in  any  other  disposi- 
tion, (2}  moneys  which  have  the  same  value  in  both  connections, 
and  (j)  moneys  which  have  less  value  as  money,  the  first  have 
the  greatest  tenacity  in  circulation,  the  third  have  the  least,  and 
the  second  something  between. 

Illustrations,  (a)  If  there  are  circulating  side  by  side  two 
gold  eagles  one  01  which  is  of  full  weight  while  the  other  is  a 
half  grain  short,  the  latter  is  more  likely  to  remain  in  circulation 
than  the  former,  (b)  Our  silver  dollar  which  circulates  at  par 
though  much  short  in  weight,  and  therefore  is  more  valuable  as 
money  than  as  bullion,  can  hardly  be  driven  out  of  circulation, 
while  full-weight  gold  coin  is  constantly  being  withdrawn,  (c) 
If  gold  and  silver  coins  which  are  full  legal  tender  and  freely 
coined  are  circulating  side  by  side,  and,  on  account  of  changes 
in  their  market  ratio,  the  silver  goes  to  a  premium  of  2  per 
cent,  the  gold  will  circulate  as  freely  as  ever,  but  the  silver  will 
almost  completely  disappear. 

The  argument  for  the  principle  is  simple.  If  a  money  is 
worth  less  for  outside  purposes  than  as  money,  no  one  will  be 
tempted  to  withdraw  it.  If  it  is  worth  more  for  outside  pur- 
poses, no  one  who  knows  that  fact  will  be  willing  to  pass  it  on  as 
money.  If  it  is  worth  the  same  in  both  relations,  people  will 
make  either  use  of  it  according  as  circumstances  dictate. 

Principle  VIII.  In  the  distribution  of  the  monetary  stock 
of  a  country,  money  of  smaller  denominations  naturally  gravi- 
tates to  the  Circulation  Proper,  i.e.,  the  part  of  the  circulation 
which  is  being  used  directly  as  a  medium  of  exchange,  money 

320 


CHAPTER  XII.     PRINCIPLES   OF  MONEY 

of  larger  denominations,  to  the  Reserves,  i.e.,  the  funds  kept  by 
banks  and  other  institutions  to  meet  credit  obligations. 

Illustration.  If  we  allow  some  particular  kind  of  money  to 
be  issued  only  in  large  denominations,  say  $25  and  upward,  we 
thereby  almost  completely  shut  such  money  out  of  the  circula- 
tion proper.  Again,  if  we  allow  another  money  to  be  issued 
only  in  $1,  $2,  and  $5  denominations,  we  almost  completely  ex- 
clude such  money  from  the  reserves,  provided  we  do  not  issue 
much  more  than  can  be  utilized  in  the  circulation  proper. 

Argument.  This  principle  has  been  proved  in  experience, 
but  is  most  easily  established  by  reference  to  the  conditions  of 
the  case.  The  circulation  proper,  the  part  of  the  money  stock 
actively  engaged  in  exchanging  goods,  will  certainly  draw  to 
itself  that  kind  of  money  which  is  fitted  for  its  special  work. 
But,  obviously,  there  will  in  ordinary  trade  be  comparatively 
little  need  for  money  of  large  denominations,  especially  in  a 
community  which  makes  much  use  of  checks,  and  great  need  for 
money  of  small  and  middle  denominations,  to  effect  purchases, 
make  change,  etc. 

ILLUSTRATIVE  PROBLEMS. 

1.  In  1849,  when  the  United  States  had  free  coinage  of  bnth 
gold   and   silver,    a   change    in   the   relative    values    of   the   two 
metals  sent  silver  coin  to  a  premium,  i.e.,  two  silver  half-dollars 
were  worth  $1.02.     What  naturally  happened  to  silver  coin? 

2.  During    the    Civil    War,    the   government    of    the    United 
States  thought  best  to  borrow  money  by  paying  soldiers,   con- 
tractors,  et  al,  with  treasury  notes.     Yet  it  was   desirous   that 
these  notes  should  not  be  added  to  the  circulating  medium,  but 
should  soon  get  into  the  hands  of  people  who  would  lay  them 
one    side   and   hold   them   till   they   were   due, — in    other   words, 
treat  them  as  bonds.    The  Treasury  finally  hit  on  a  pretty  good 
plan  to  accomplish  this.     What  was  it? 

3.  In   1862,   when   gold   payment   on   treasury   notes   had   al- 
ready  been    suspended,   the   United    States   began   the    issue    of 
legal   tender   notes.     In  consequence  gold  went  to   a  premium, 
soon   being  worth   $1.15   per  dollar.     What   naturally  happened 
to   it? 

4.  Experts   consider    it   very   desirable   that    the   bank   note 
circulation   should  be   elastic, — should  expand   readily  when  the 
need  for  money  increases  and  contract  promptly  when  the  need 
diminishes.     Of  these  two  phases  of  elasticity,  the  second  is  in 
a  sense  the  more  important,  in  that  it  really  provides  for  the 
first.     In  order  to  secure  this  power  of  prompt  contraction,  vari- 
ous provisions  have  been  enacted  or  proposed;    (a)   establish  a 

321 


PRINCIPLES  OF  ECONOMICS 

good  many  redemption  agencies  at  convenient  points  throughout 
the  country;  (b)  prohibit  any  bank  from  paying  out  in  regular 
business  the  notes  of  another  bank  except  in  the  city  or  district 
where  the  issuing  bank  is  located;  (c)  prohibit  the  use  of  bank 
notes  as  reserves  by  banks  outside  the  system;  (d)  take  away 
the  right  of  legal  tender  to  government ;  and  so  on. 

Explain  in  each  case  why  the  provision  set  forth  would  nat- 
urally contribute  to  the  contractility  of  the  note  circulation. 

5.  In    1894,    on    account    of    excessive    issue    of    silver    ?.nd 
paper  money,  as  also  on  account  of  the  marked  decline  \n  busi- 
ness activity,  the  United  States  had  a  great  excess  of  circulating 
medium.     This   fact    (combined,   doubtless,   with    other   causes) 
led  to  a  considerable  contraction  by  export  to  other  countries. 
What  kind  of  money  must  have  gone? 

6.  In  1886,  Congress  provided  by  law  'for  the  issue  of  silver 
certificates  of  $i,  $2,  and  $5  denominations,  and  in  1900  decreed 
that  90  per  cent  of  the  total  amount  of  such  certificates  should 
be  in  denominations  from  $10  down.    Try  to  find  out  what  they 
hoped  to  accomplish  by  this  legislation. 

Section  C.     Movements  and  Distribution  of  Money. 

In  spite  of  the  fact  that  money  payments  between  differem 
communities  are  largely  effected  by  a  cancellation  of  reciprocal 
credits,  there  necessarily  take  place  many  transfers  of  money 
itself.  These  money  movements  are  often  of  importance,  both 
because  at  times  they  tend  to  modify  in  undesirable  ways  the 
distribution  of  the  monetary  stock  among  different  communities 
and  because  at  times  they  indicate  more  or  less  diseased  condi- 
tions of  the  industrial  or  monetary  system  as  a  whole.  We  here 
set  forth  a  few  of  the  most  important  principles  regulating  these 
movements. 

Principle  IX.  The  dealings  of  one  country  (community') 
with  other  countries  in  respect  to  goods  and  capital  do  not  in 
themselves  naturally  lead  to  net  movements  of  money  either  to 
or  from  said  country;  but,  if  circumstances  are  such  as  to  main- 
tain a  balance  of  claims  for  or  against  said  country  for  a  period 
of  several  weeks,  a  net  movement  of  money  to  or  from  that 
country  is  probable. 

Argument.  A.  The  first  clause  of  the  theorem  needs  to  be 
established  under  each  of  two  hypotheses;  (1)  when  interna- 
tional dealings  are  affected  through  credit  mostly,  and  (2)  when 
such  dealings  are  effected  through  cash  payments.  Under  hypo- 
thesis (1),  the  truth  of  the  theorem  is  evident.  The  principle 
that  trade  is  in  its  nature  reciprocal,  which  we  had  early  in  our 

322 


CHAPTER  XII.     PRINCIPLES   OF  MONEY 

course,  tells  us  that  we  shall  sell  as  well  as  buy, — that  claims  for 
us  will  naturally  match  claims  against  us.  Consequently,  trade 
as  such  will  not  naturally  lead  to  any  movement  of  money. 
Under  hypothesis  (2),  money  movements,  by  the  terms  of  that 
hypothesis,  take  place;  but  these  are  not  net  movements — move- 
ments which  show  a  balance  one  way  or  the  other.  The  for- 
eigner does  not  naturally  take  from  us  more  money  than  he 
brings  to  us;  because  his  only  use  for  money  is  to  buy  things. 
Money  is  a  mere  go-between;  the  real  thing  sellers  want  is  the 
good  they  later  buy  with  money.  Money,  therefore,  naturally 
comes  back  as  surely  as  it  goes  away. 

B.  The  second  part  of  the  theorem  is  no  more  troublesome 
than  the  first.  If  a  country  is  for  several  weeks  selling  much 
more  than  it  buys,  so  that  there  is  a  large  balance  of  claims  in 
its  favor,  its  bankers  or  exchange  dealers  will  be  unwilling  to 
wait  for  their  pay  till  the  tide  turns  and  so  will  probably  order 
money  itself  sent  to  them. 

Corollary  1.  Money  tends  to  How  to  any  country  (community} 
where  the  rate  of  discount  is  exceptionally  high,  and  vice  versa. 

Argument.  Such  a  condition  of  things  tends  to  cause  a  flow 
of  capital  to  said  country,  hence  tends  to  establish  a  balance  of 
claims  in  favor  of  that  country,  and  so  tends  to  bring  ii.'to  opera- 
tion Principle  IX. 

Corollary  2.  Money  tends  to  How  from  a  country  where  the 
stock  is  abnormally  large  as  indicated  by  the  state  of  the  central 
reserves. 

Argument.  This  corollary  follows  from  its  predecessor.  An 
excessive  money  stock  causes  excessively  large  bank  reserves, 
which  cause  a  fall  in  the  rate  of  discount,  which  brings  Corollary 
1  into  operation.  In  extreme  cases,  an  excess  of  money  raises 
prices,  and  by  this  causes  an  inflow  of  imports,  then  a  balance 
against  the  country,  and  finally  an  outflow  of  money. 

Corollary  3.  There  tends  to  be  a  continuous  net  How  of 
money  from  a  country  which  is  a  producer  of  standard  money 
metal. 

Argument.  The  natural  and  easy  way  to  market  standard 
money  metal  is  to  take  it,  directly  or  indirectly,  to  the  mint,  have 
it  turned  into  money,  and  sell  it  as  money,  i.  e.,  spend  it  for 
goods.  But  this  means  that  the  money  stock  of  a  gold  pro- 
ducing country  is  being  constantly  augmented,  and  is  constantly 

323 


PRINCIPLES  OF  ECONOMICS 

becoming  excessive.      This  brings  into  operation  Corollary  2. 

Corollary  4.  Money  tends  to  flow  from  any  country  which 
has  experienced  a  marked  decline  in  industrial  activity. 

Argument.  The  condition  named  makes  the  money  stock 
excessive, — since  there  is  less  money  work  to  be  done, — and  so- 
brings  into  operation  Corollary  2. 

Corollary  5.  //  a  full  weight  metallic  money  comes  to  com- 
mand a  premium,  it  tends  to  be  exported  from  the  country. 

Argument.  When  such  a  money  goes  to  a  premium,  it  natur- 
ally ceases  to  circulate — to  be  used  as  money,  Principle  VII 
above.  But,  ceasing  to  be  used  as  money,  it  is  thrown  on  the 
metal  market,  making  the  supply  excessive  and  hence  making  its 
value  at  home  low  as  compared  with  its  value  in  other  countries. 
That  is,  the  premium  it  bears  at  home  is  less  than  its  value 
abroad  would  seem  to  justify.  It  is,  therefore,  exported. 

Principle  X.  Every  net  movement  of  money  tends  to  be 
stopped,  or  even  reversed,  by  the  automatic  reversal  of  that  con- 
dition which  is  necessary  to  bring  it  about,  or  by  the  action  of 
conditions  zvJiich  its  own  continuance  sets  up. 

Argument.  (Reading  XVI.)  A.  A  money  movement — e.g., 
an  outflow — tends  to  be  stopped,  even  reversed,  by  the  automatic 
reversal  of  the  condition  which  immediately  brings  it  about, 
The  condition  here  alluded  to  is  a  high  rate  of  exchange.  With- 
out such  a  high  rate,  money  will  not  normally  go.  But  a  high 
rate  of  exchange  is,  so  to  speak,  self-reversing,  in  that  it  makes 
the  exporting  of  goods  unusually  profitable,  hence  stimulates 
competition  among  exporters,  so  leads  them  to  shade  prices,  con- 
sequently stimulates  foreign  buying,  thus  makes  exchange  abun- 
dant, and  so  lowers  the  rate. 

B.  A  money  outflow,  if  long  continued,  sets  up  conditions 
which  tend  to  stop  or  reverse  the  movement.  Such  an  outflow 
makes  banking  reserves  in  the  commercial  centers  (New  York, 
London)  scanty,  hence  raises  the  rate  of  discount,  therefore 
checks  buying  of  securities,  consequently  lowers  their  prices, 
hence  stimulates  foreign  buying,  thus  makes  exchange  abundant,, 
therefore  lowers  the  rate  of  exchange,  and  so  removes  the  con- 
dition which  is  necessary  to  further  outflow. 

Corollary.     There  is  never   any  danger   that  an   outflow   of 
324 


CHAPTER  XII.     PRINCIPLES   OF  MONEY 

money  from  a  particular  country  will  go  on  till  that  country  is 
denuded  of  its  monetary  stock. 

Principle  XI.  Generally  speaking,  the  monetary  stock  of  a 
country,  or  group  of  countries  having  the  same  standard,  tends 
to  distribute  itself  according  to  relative  need. 

Argument.  This  principle  ought  perhaps  to  be  given  as  a 
corollary  under  Principle  IX.  But  its  importance  justifies  its 
presentation  as  a  separate  theorem.  The  reasoning  on  which  it 
is  based  is  simple.  If  the  monetary  stock  of  a  particular  country 
is  relatively  excessive,  bank  reserves  expand,  the  prices  of  secur- 
ities (and  ultimately  of  goods)  rise,  foreigners  sell  freely  on 
our  markets,  our  foreign  debt  expands,  exchange  rises,  and 
money  goes,  thus  reducing  the  plethora.  On  the  other  hand,  a 
relatively  deficient  stock  of  money  makes  bank  reserves  low,  the 
rate  of  discount  (not  exchange)  rises,  home  buying  falls  off, 
prices  fall,  foreign  buying  is  stimulated,  exchange  becomes 
abundant,  the  rate  of  exchange  falls,  and  money  flows  in. 

The  above  argument  treats  the  matter  as  things  work  between 
highly  developed  commercial  nations  in  the  ordinary  course  of 
things.  As  between  the  small  communities  where  standard 
money  metal  (gold)  is  produced,  e.  g.,  South  Africa,  the  Klon- 
dike, etc.,  and  the  rest  of  the  world,  the  working  of  things  is,  if 
anything,  more  simple.  The  extraordinary  abundance  of  money 
(lor  gold  hete  at  once  becomes  money  even  in  its  raw  form) 
and  the  great  scarcity  of  all  other  goods  makes  prices  excessively 
high,  goods  flow  in  at  an  extraordinary  rate,  the  community  has 
constantly  a  large  balance  of  indebtedness  against  it,  and  money 
must  constantly  be  sent  out. 

Principle  XII.  While,  in  general,  the  proper  distribution  of 
the  world's  monetary  stock  among  'the  different  nations  can  safely 
be  left  to  the  working  of  automatic  forces,  circumstances  wiy 
arise  under  which  it  is  desirable  consciously  to  control  particular 
movements  of  money,  in  order  to  maintain  the  stability  of  the 
system  of  credit. 

Argument.  The  student  is  already  familiar  with  the  fact  that 
our  exchanging  medium  consists  in  large  part  of  credit  money, 
promises  to  pay  real  money,  and,  in  still  larger  part,  of  mere 
credit,  bank  credit,  deposit  currency.  Now,  it  is  plain  that, 
under  such  an  order  of  things,  the  foundation  of  real  money  on 
which  the  whole  system  rests,  is  vastly  more  important  than  any 

325 


PRINCIPLES  OF  ECONOMICS 

other  constituent  of  the  circulating  medium  ;  and  this  is  particu- 
larly true  of  that  portion  of  the  stock  of  real  money  which  we 
call  the  ultimate  reserve,  the  reserve  kept  by  a  great  central  bank 
or,  as  in  our  case,  by  the  government  to  redeem  credit  money. 
If  this  reserve  is  exhausted,  the  standard  goes,  the  svstem  falls 
to  the  ground.  Thus,  every  export  of  standard  money  threaten?' 
to  take  away  the  v^ry  foundation  of  the  system.  It  is,  there- 
fore, perfectly  natural  that  the  banking  community  should  view 
with  apprehension  an  excessive  outflow  of  such  standard  money. 
It  is  also  perfectly  natural  that,  if  such  an  excessive  outflow 
continues,  they  should'  call  for  some  action  on  the  part  of  gov- 
ernment or  of  the  central  bank  to  check  the  outflow.  As  a 
matter  of  fact,  the  great  banks  of  Europe  have  developed  several 
more  or  less  efficient  devices,  policies,  having  this  end  in  view. 
Of  these  the  most  important  consists  in  raising  the  rate  of 
discount  and  thus  bringing  into  operation  Corollary  1  of  Prin- 
ciple IX. 

ILLUSTRATIVE  PROBLEMS. 

1.  "When  I  came  to  Marblehead  they  had  their  houses  built 
by  country  workmen,  and  their  clothes  made  out  of  town,  and 
supplied   themselves   with   beef  and    pork    from    Boston,   which 
drained    the    town    of    its    money." — Barnard's    Autobiography. 
Criticise  the  part  in  italics. 

2.  During  the  years  1853  to  1864,  inclusive,  when  France  had 
a  system  of  bimetallism  at  a  coinage  ratio  of  15.5  to  1,  while  the 
market  ratio   was   about   15.3  to   1,  the   French   circulation   ab- 
sorbed about  $680,000,000  of  gold,  and  ejected  about  $345,000,000 
of  silver.      Explain  these  facts,  using  one  of  the  corollaries  of 
Principle  IX. 

3.  Between  America  and  Europe  there  is  usually  a  net  move- 
ment of  money  toward  Europe  during  the  second  quarter  of  the 
year,  toward  America  near  the  end  of  the  third,  and  early  in  the 
fourth,  quarter."     Explain  why  you  would  expect  this  to  be  true. 

4.  "A  country  has  never  been  despoiled  of  its  money  by  the 
working  of  its   international  trade." — Gide's   Political  Economy, 
p.  120.      Why  does  he  feel  so  sure  about  this? 

5.  A  New  York  wheat  broker  sells  50,000  bushels  of  wheat 
to  a  Liverpool  miller,  and  sells  against  it  a  sight  bill  of  exchange 
for  the  proceeds,    £8735  16s.     The  wheat  cost  him  84  cents  per 
bushel. 

(a)  With    exchange    on    London    at    $4.88,    what    would    his 
profits  be? 

(b)  What  would  they  be  with  exchange  at  $4.84? 

(c)  What    has    this    got    to    do    with    money    movements? 
Explain  carefully. 

326 


CHAPTER  XII.     PRINCIPLES   OF  MONEY 

6.  "Between   New  York  city,  as  the  banking  center  of  the 
United  States,  and  the  country  at  large,  there  is  usually  a  great 
money  movement  outward  from  New  York  during  the  summer 
and    early    fall,    and    an    inward    movement    toward    New    York 
during  the  late  fall  or  early  winter.''     Explain  why  you  would 
expect  this  to  be  true. 

7.  Argument  for  a  subsidy  to  the  American  merchant  marine : 
"We  pay  no  million  dollars  per  annum  for  the  carrying  of 

products  between  this  and  foreign  countries.  Think  of  it.  One 
hundred  and  ten  million  dollars  in  gold  coin  has  gone  out  of  the 
commerce  of  this  country  into  the  commerce  of  other  countries. 
Can  New  York  stand  this?"— James  G.  Elaine,  1881.  (a)  Did 
our  paying  $110,000.000  for  the  carrying  of  products  mean  that 
$110,000,000  in  gold  coin  went  out  of  this  country  each  year? 
(b)  If  $110,000,000  in  gold  coin  were  to  go  each  }ear  tor  this 
purpose,  would  we  be  any  poorer  because  of  it?  (c)  Would  it 
be  any  better  if  we  could  meet  the  obligation  by  sending  out 
$110,000,000  worth  of  cotton  or  wheat  rather  than  so  much  gold? 
(d)  Could  we,  as  a  matter  of  fact,  send  out  $110,000,00  in  gold 
each  year  for  this  or  any  other  purpose?  Why? 

Section  D.    The  Value  of  Money. 

Thus  far  in  our  discussion  of  value  and  price,  it  has  been 
assumed  that  money  itself,  the  thing  in  which  the  values  of  most 
goods  are  expressed,  is  constant  in  value.  This  way  of  conceiv- 
ing the  matter  has  been  encouraged  by  our  emphasis  on  the 
idea  that  the  money  unit  is  tied  to  a  certain  definite  quantity  of 
substance,  say  25.8  grains  of  gold,  just  as  a  gallon  measure  is 
tied  to  8.33  pounds  of  water.  But  we  must  now  call  the  student's 
attention  to  the  fact  that  such  a  way  of  looking  at  the  matter 
is  more  or  less  inaccurate.  The  cases  of  the  money  standard 
and  the  liquid  measure  standard  are  not  precisely  analogous. 
In  using  8.33'  pounds  of  water  as  a  standard  of  liquid  measure, 
we  need  have  no  anxiety  that  the  bulk  of  the  water  itself  will 
change,  and  so  cause  that  of  our  unit  to  change,  since  we  can 
make  those  conditions  which  can  modify  the  bulk  of  water — 
temperature  and  atmospheric  pressure — absolutely  the  same  in  all 
cases.  But  we  can  not  parallel  such  an  operation  with  gold  and 
its  value.  We  can  not  say  that  we  will  have  as  our  money 
standard  the  value  of  25.8  grains  of  gold  under  just  the  same 
essential  conditions  as  prevailed  when  it  was  finally  adopted  in 
1873;  for  we  can  never  reproduce  those  conditions.  All  we  can 
do.  and  all  we  try  to  do,  is  to  keep  the  value  of  one  dollar  the 
same  at  any  one  time  as  the  value  of  25.8  grains  of  gold  is  at 

327 


PRINCIPLES  OF  ECONOMICS 

that  same  time.  We  know  that  in  so  doing  we  are  tieing  the 
dollar  to  something  which  itself  changes.  But  we  are  doing 
what  seems  the  best  thing  possible  under  all  the  conditions  ot 
the  case.  Gold  probably  changes  as  little  as  any  single  com- 
modity. Further,  as  being  the  standard  of  all  important  coun- 
tries, it  is  far  better  than  any  other.  But  it  no  doubt  changes 
in  value,  and  so,  of  course,  our  money  changes  in  value. 

We  have  just  said  that  gold,  and  so  money,  undoubtedly 
changes  in  value.  But  it  is  not  as  easy  to  establish  the  fact  of 
change  or  to  measure  its  amount  as  the  student  might  imagine. 
Gold  being  the  standard  of  all  great  commercial  nations,  there  is 
practically  no  market  where  its  value  is  expressed  in  terms  of 
something  besides  itself.  There  is,  therefore,  practically  no 
place  where  its  apparent  value,  its  money  price,  changes  at  all. 
In  the  United  States  it  is  always  worth  $18.67  per  ounce ;  in 
Great  Britain,  £3  17s  lO^d  per  ounce;  and  so  on.  Our  only 
method  of  ascertaining  changes  in  the  value  of  moneys  is  to 
study  the  movements  of  the  prices  of  other  things.  If  gold, 
and  so  money,  should  all  at  once  greatly  rise  in  value,  its  own 
price  would  remain  constant,  but  that  of  every  other  thing  would 
fall.  On  the  other  hand,  a  sudden  fall  in  the  value  of  gold 
v/ould  show  in  a  rise  of  the  prices  of  all  other  things.  It  would 
seem,  therefore,  that  we  need  only  to  ascertain  the  changes  in 
the  general  level  of  prices  to  know  the  changes  in  the  value  of 
money;  and,  in  large  measure,  this  is  what  we  try  to  do. 

But  here  again  we  find  trouble.  Changes  in  the  value  of 
money  would  surely  express  themselves  in  opposite  changes  in 
the  level  of  prices.  But  the  level  of  prices  may  be  changed  by 
other  causes ;  e.  g.,  sudden  collapse  of  business  demand,  great 
fall  in  cost  of  production.  In  other  words,  a  change  in  the 
general  price  level  may  really  be,  not  a  change  in  the  value  of 
money,  but  a  change  in  the  value  of  goods.  Or,  if  this  method 
of  expressing  the  matter  is  objectionable,  we  may  say  that  some 
changes  in  the  general  level  of  prices  have  their  origin  in  causes 
affecting  goods  rather  than  money,  and,  if  called  changes  in  the 
value  of  money  at  all,  these  may  be  distinguished  as  relative 
changes ;  while  changes  in  the  price  level  due  to  causes  acting  on 
money  itself  would  be  called  absolute  changes. 

The  preceding  discussion  has  brought  out  the  nature  of 
changes  in  the  value  of  money,  let  us  now  remark  on  the  most 
important  principles  governing  these  changes. 


CHAPTER  XII.     PRINCIPLES   OF  MONEY 

Principle  XIII.  //  there  takes  place  any  change  in  condi- 
tions outside  the  monetary  system  tending  to  cause  a  change  in 
the  supply  of,  or  the  demand  for,  goods  in  general,  or  to  cause 
a  widespread  change  in  the  cost  of  producing  goods,  said  change 
in  conditions  will  also  tend  to  cause  the  corresponding  cliange  in 
the  general  price  level;  -but  such  a  change  will  be  merely  a  rela- 
tive, not  an  absolute,  change  in  the  value  of  money. 

Illustrations.  A.  When,  after  a  period  of  industrial  stagna- 
tion, business  begins  to  pick  up,— people  begin  to  have  faith  in 
the  future, — there  naturally  takes  place  a  considerable  expansion 
of  demand  for  goods  of  all  sorts,  and  in  consequence  a  measur- 
able rise  in  prices,  beginning  among  a  few  commodities  but 
gradually  extending  until  it  covers,  if  not  the  whole  field,  at 
least  a  large  portion  of  it.  As  the  boom  advances,  this  move- 
ment becomes  more  and  more  pronounced.  Every  one  believes 
prices  will  go  higher,  and  so  is  eager  to  buy,  that  he  may  have 
something  to  sell  at  these  higher  prices.  But  of  course  his 
eagerness  to  buy  means  more  demand  and  so  more  advance  in 
prices.  This  self-propagating  movement  continues  until  the 
expansion  has  passed  all  reasonable  bounds,  when  suddenly  some 
accident  precipitates  a  general  collapse  of  the  boom, — pricks  the 
speculative  bubble.  At  once  all  are  eager  to  sell,  no  one  want- 
ing to  buy ;  and  this  sudden  expansion  of  supply  and  contraction 
of  demand  causes  a  falling  off  of  prices,  more  rapid  probably 
than  the  rise  has  been. 

B.  If  throughout  a  period  of  considerable  length,  say  be- 
tween 1850  and  1890,  there  occurs  a  widespread  improvement  in 
technical  methods  so  that  the  costs  of  producing  large  numbers 
of  commodities  are  greatly  reduced,  there  naturally  follows  a 
decline  in  the  prices  of  these  commodities,  so  marked  as  to 
iower  considerably  the  average,  or  general,  price  level.  But 
such  a  lowering  of  the  general  price  level  could  not  properly 
be  conceived  as  a  real  or  absolute  advance  in  money.  It  has 
taken  place,  not  because  something  has  happened  to  money, 
hut  because  something  has  happened  to  goods.  To  employ  a 
common  method  of  expression,  it  is  not  a  change  in  the  value  of 
money  at  all,  but  rather  a  change  in  the  value  of  goods. 

These  illustrations  of  the  Principle  would  seem  to  furnish 
all  the  argument  it  needs.  In  fact,  the  theorem  is  formally 
presented  chiefly  to  guard  the  student  against  confusing  price 
changes  of  the  kind  here  considered  with  those  more  important 

329 


PRINCIPLES  OF  ECONOMICS 

ones  which  constitute  real  or  absolute  changes  in  the  value  of 
money. 

Principle  XIV.  Whenever  the  conditions  are  such  that  it 
is  possible  for  the  general  public  to  have  substantially  conclusive 
evidence  that  a  change  in  the  value  of  the  standard,  as  meas- 
ured in  at  least  one  important  commodity,  has  taken  place,  there 
will  almost  certainly  follow,  more  or  less  rapidly,  a  direct  read- 
justment of  general  prices  to  the  changed  standard. 

Illustration.  A.  Before  1893,  India  had  a  silver  standard;  at 
the  same  time  the  value  of  silver  was  constantly  fluctuating  in 
the  London  market;  and  these  fluctuations  were  manifested  in 
India  by  changes  in  the  rate  of  exchange  on  London.  Under 
these  conditions  frequent  readjustments  in  the  prices  of  goods — 
particularly  the  prices  of  imported  goods — took  place  in  re- 
sponse to  the  changes  which  occurred  in  the  value  of  silver. 

B.  During  the  Civil  War  in  the  United  States,  the  standard 
money — greenbacks — greatly  fluctuated  in  value,  as  measured  in 
gold,  which  it  had  temporarily  displaced.  Its  buying  power  as 
money  also  fluctuated  in  a  fashion  roughly  corresponding  to  its 
fluctuations  as  measured  in  gold, — a  result  which  seems  to  have 
been  affected  by  a  more  or  less  conscious  readjustment  of  prices 
to  changes  in  the  value  of  standard  money  (greenbacks)  as 
measured  in  gold. 

This  principle,  like  the  one  preceding,  hardly  seems  to  need 
further  proof  than  the  illustrations  furnish.  We  could  probably 
be  sure  that  business  men  of  experience,  alert  and  shewd,  would 
refuse  to  sell  goods  at  the  old  prices  for  money  which  had  fallen 
twenty  to  thirty  per  cent  in  what  they  were  accustomed  to  con- 
sider the  world  standard. 

Principle  XV.  During  a  period  marked  by  much  uncertainty, 
either  political  or  commercial,  the  value  of  irredeemable  paper 
money  is  chiefly  determined  by  public  confidence  in  its  ultimate 
redemption,  varying  directly  as  said  public  confidence. 

Argument.  (1.)  The  value  of  said  irredeemable  paper,  as 
measured  in  the  standard  money  in  which  credit  money  has 
hitherto  been  redeemed,  is  in  a  time  of  much  uncertainty  chiefly 
dependent  on  the  likelihood  that  redemption  will  be  resumed. 
This  seems  almost  self-evident.  Great  uncertainty  of  any  sort, 
fears  of  defeat  in  war,  anxiety  lest  government  should  repudiate 
in  greater  or  less  degree  its  note  obligations, — these  naturally 

330 


CHAPTER  XII.     PRINCIPLES   OF  MONEY 

overbalance  all  other  forces,  making  a  note  worth  60  cents  today, 
43  tomorrow,  55  the  next,  and  so  on. 

(2.)  But,  if  the  value  of  irredeemable  paper,  as  measured  in 
the  old  standard,  fluctuates  with  public  confidence  in  its  ultimate 
redemption,  and  if,  as  declared  in  Principle  XIV,  the  value  of 
such  paper,  as  money  used  to  buy  goods,  is  roughly  readjusted 
to  its  value  as  measured  in  the  old  standard,  then  the  value  of 
such  paper  varies  with  public  confidence  in  its  ultimate  re- 
demption. 

Principle  XVI.  //  there  takes  place  any  change  in  condi- 
tions directly  affecting  money  itself  which  tends  to  cause  a 
change  in  the  demand  for  goods  in  general,  said  change  in  con- 
ditions will  also  tend  to  cause  a  corresponding  change  in  the 
general  price  level,  and  such  change  will  constitute  an  absolute1 
change  in  the  value  of  money. 

Illustration.  Suppose  that  in  a  community  which  contains  only 
a  few  thousand  inhabitants  there  occurs  a  great  gold  discovery, 
and  in  a  few  months  bullion  to  the  value  of  hundreds  of  thou- 
sands of  dollars  is  brought  out.  As  such  bullion  can  be  almost 
instantly  turned  into  money  or  its  equivalent  bank  credit,  there 
will  take  place  at  once  a  great  expansion  in  the  money  demand 
for  all  sorts  of  goods,  while  no  corresponding  increase  in  their 
output  takes  place.  (In  fact,  the  latter  rather  diminishes  be- 
cause people  desert  other  industries  to  hunt  for  gold.)  In  con- 
sequence, a  rapid  rise  in  general  prices  takes  place.  And  this 
rise  in  prices  is  a  real  or  absolute  fall  in  the  value  of  money; 
since  it  is  obviously  the  increase  of  money  or  its  cheapening 
(in  cost)  or  both  which  cause  the  change. 

The  above  illustration  contains  the  gist  of  the  argument  for 
the  Principle. 

Corollary  1.  The  value  of  money  tends  to  vary  inversely  as 
the  total  quantity  of  money  in  general  in  the  country  or  in  the 
whole  group  of  countries  having  the  same  standard. 

Argument.  If  the  quantity  of  money  increases,  the  demand 
for  goods  naturally  increases,  and  so  the  level  of  prices  tends 
to  rise,  i.  e.,  the  value  of  money  tends  to  fall.  A  similar  course 
of  reasoning  would  show  that  a  diminution  in  the  volume  of 
money  tends  to  increase  its  value. 

Caution.  It  is  probable  that  under  modern  conditions  few 
actual  changes  in  the  value  of  money  are  traceable  to  changes 

331 


PRINCIPLES  OF  ECONOMICS 

in  the  total  quantity,  save  in  countries  which  have  a  fiat  money 
for  the  standard,  or  in  small  districts  where  standard  money 
tnetals  are  being  mined. 

The  reason  for  this  is  that  there  is  a  very  high  degree  of 
elasticity  in  the  monetary  system  of  almost  any  advanced  coun- 
try, and  so  changes  in  volume  whether  causing  excess  or  de- 
ficiency, are  ^  easily  corrected.  This  great  elasticity  is  due  to 
various  conditions,  (i)  As  most  nations  have  the  same  standard 
— gold — a  deficiency  in  one  is  easily  made  good  by  imports  from 
elsewhere,  while  an  excess  is  easily  relieved  by  export.  (2)  Most 
advanced  commercial  peoples  make  an  extensive  use  of  credit 
media  of  exchange,  and  these  are  in  the  highest  degree  elastic, 
expanding  or  contracting  rather  as  the  needs  of  business  expand 
or  contract  than  as  the  volume  of  money  changes.  (3)  In  most 
cases  one  of  the  moneys  (the  bank  note)  n  highly  elastic. 

Corollary  2.  The  value  of  money  tends  to  vary  inversely  as 
the  quantity  of  standard  money  available,  and  hence  to  vary 
inversely  as  the  output  of  metal,  directly  as  the  cost,  directly 
us  the  quantity  used  in  the  arts,  and  so  on. 

Argument.  A.  In  so  far  as  changes  in  the  quantity  of 
standard  money  affect  the  total  quantity  of  money,  they  ob- 
viously tend  to  bring  into  operation  Corollary  i. 

B.  But  changes  in  the  quantity  of  standard  money  have  other 
more  potent  methods  of  influencing  the  value  of  money.  This 
kind  of  money,  as  we  have  remarked  more  than  once,  occupies 
a  very  fundamental  place  in  the  system.  A  deficiency  or  excess 
of  such  money  is  more  promptly  felt  than  a  deficiency  or  excess 
of  any  other  kind.  In  the  chief  commercial  center  of  the  coun- 
try there  must  be  kept  one  or  more  great  reserves  of  standard 
money  to  secure  the  maintenance  of  the  system  as  a  whole.  In 
most  countries  this  reserve  of  standard  money  is  identical  with 
the  ultimate  banking  reserve;  so  that  excess  or  deficiency  in 
standard  money  means  excess  or  deficiency  in  the  reserve  which, 
as  we  saw  under  Principle  X,  plays  such  a  part  in  the  outflow 
or  inflow  of  money.  Under  such  a  system,  the  addition  of  a 
few  millions  of  gold,  constituting  a  very  small  fraction  of  the 
total  money  stock  of  the  country,  might  establish  that  super- 
fluity in  the  central  reserves  which  causes  a  low  rate  of  dis- 
count and  so  a  rise  in  prices,  while  a  similar  subtraction  of  only 
a  few  millions  would  bring  about  that  deficiency  which  causes  a 
rise  in  the  rate  of  discount  and  so  a  fall  in  prices.  In  the  case 
of  the  United  States,  changes  in  the  amount  of  standard  money 
are  not  so  potent,  since  we  use  for  the  central  reserve  not  only 

332 


CHAPTER  .XII.     PRINCIPLES   OF  MONEY 

gold  but  also  legal  tender  treasury  notes.*  Even  so,  however, 
changes  in  the  quantity  of  standard  money,  as  being  one  of  the 
only  two  moneys  which  do  make  up  those  reserves,  affects  their 
volume  very  decidedly,  as  bank  notes,  silve-r,  etc.,  usually  can 
not ;  and,  therefore,  such  changes  in  the  quantity  of  standard 
'iioney  have  much  more  power  to  influence  the  general  level  of 
prices,  i.  e.,  the  value  of  money. 

Caution.  While  changes  in  the  quantity  of  standard  money, 
and  so  of  standard  metal,  are  doubtless  more  potent  to  alter  the 
value  of  money  than  are  changes  in  the  quantity  of  money  in 
general ;  still,  theory  and  experience  alike  indicate  that  changes 
in  the  value  of  money  certainly  traceable  to  this  cause  are  un- 
expectedly small  in  amount.  This  certainly  proved  true  of  the 
additions  to  the  stock  of  gold  due  to  the  famous  Californian 
and  Australian  discoveries.  Whether  a  similar  statement  will 
prove  true  of  the  recent  extraordinary  expansion  of  gold  pro- 
duction, no  one  can  as  yet  tell  us.  Money  has  probably  some- 
what fallen  in  value  from  this  cause ;  but  the  fall  has  probably 
been  smaller  than  the  public  commonly  suppose,  and  may  in  the 
end  prove  insignificant. 

Corollary  3.  The  value  of  money  in  any  country,  or  group 
of  countries  having  the  same  standard,  tends  to  vary  directly  as 
ihe  need  for  it,  i.  e.,  as  the  money  work  to  be  done, — especially 
as  the  need  for  standard  rnone?  . 

Illustration.  When,  in  a  country  making  large  use  of  credit- 
exchange,  there  takes  place  a  collapse  of  credit  such  as  marks 
a  panic,  so  that  credit  media  of  exchange  will  no  longer  do  the 
work— money  only  will  be  accepted, — almost  certainly  there  will 
occur  a  marked  fall  in  general  prices,  i.e.,  a  rise  in  the  value  of 
money. 

Argument.  The  student  can  easily  construct  the  argument 
for  this  corollary  for  himself.  It  is  almost  identical  with  what 
is  given  under  Corollaries  1  and  2. 

MISCELLANEOUS    PROBLEMS    UNDER    MONEY. 

1.  "I  can't  understand  what  people  mean  when  they  say 
*.hat  money  has  risen  in  value  since  1873.  Money  is  by  common 
consent  the  measure  of  the  values  of  all  other  things;  and  so 
its  own  value  must  be  -fixed, — can  not  rise  or  fall." — From  a 
gold  advocate  in  1896.  Explain  his  mistake. 

X.  Why  would  changes  in  the  total  quantity  of  money  in  the 
United  States  between  1862  and  1879  naturally  have  had  more 

*We  might  use  silver  dollars  also,  since  they  are  a  full  legal  tender; 
but  we  do  not  in  fact  do  so  to  any  considerable  extent. 

333 


PRINCIPLES  OF  ECONOMICS 

influence  on  its  value  than  equal  changes  would  have .  had  be- 
tween 1850  and  1860? 

3.  Extract  from  a  speech  in  the  campaign  of  1896 :    "If  any 
m,an  in  this  community  would  offer  to  buy  all  the   eggs  at  25 
cents   a   dozen,   and   was   able   to  make  good   the  offer,   nobody 
would  sell  eggs  for  less,  no  matter  what  the  cost  of  production, 
whether  one  cent  or  five  cents  a  dozen.     So  with  silver.     Free 
coinage  would  establish  the  market  price  of  silver  at  $1.29,  and 
nobody  would  sell  for  a  cent  less." 

There  is  doubtless  a  sense  in  which  the  italicized  claim  is 
true;  Dut  this  is  'not  the  sense  which  was  intended.  The 
speaker  meant  that  silver  would  rise  to  $1.29,  as  measured  in  the 
present  dollar;  so  that  there  would  be  no  repudiation  of  debts 
in  adopting  the  free  coinage  of  silver. 

fa)  Show  that  such  a  claim  is  rot  established  by  this 
argument. 

(b)     In  what  sense  is  the  statement  true? 

4.  "We    have    altogether    too    little    money    in  the    country 
($2,600,000)    not   enough   to   pay   the    railway   debt  ($6,000,000), 
or  even  the  debts  of  banks  to  depositors,  let  alone  the  business 
debts."    Explain  fallacy. 

5.  A   few  years  ago   Mexico   had   a   silver  standard.     If  at 
that  time  silver  had  risen   in  value,  would   the   Mexican   dollar 
have  risen   in  value?     Would   it  have   risen  in   price?     Would 
the  price  of  silver  bullion  have  risen? 

6.  In  1856  the  monetary  system  of  France  was  bimetallism 
at  the   ratio   of  15.5  to   1.     The   market   ratio  at  that  date   was 
about  15.3  to  1.     What  must  have  been  the  monetary  standard? 
Prove. 

7.  In   the   panic   of   1893,   when   in   America   money   was    so 
scarce  that  business  men  and  bankers  had  to  resort  to  all  sorts 
of  substitutes,  such  as  due  bills,  New  York  drafts,  deposit  cer- 
tificates, etc.,  an  eminent  American  economist  said  in  substance  : 
"What    do    you   think    now?      Was    I    not    right    in    contending 
that   the    stock   of   money   is    altogether   insufficient?"      Did    tne 
facts  establish  his  contention? 

8.  Argument   against    Bryan   in   the   campaign    of   1896:      '1 
can  see  how  free  coinage  is  going  to  increase  the  profits  of  the 
mine  owners  by  doubling  the  value  of  silver ;  but  I  do  not  see 
how  it  is  going  to  help  the  rest  of  us."     Explain  the  fallacy  m 
the  words  italicized. 

9.  During  the  sixth  decade  of  the  XIX  Century  when  France 
had  bimetallism  at  a  ratio  of  15.5  to  1,  though  the  market  ratio 
was  about   15.3   to   1,    dealers   to    their   surprise   every  now    and 
then  received  silver  five-franc  pieces  in  payment  for  goods.  Why 
should  this  have  surprised  them? 

10.  "Unless  the  government  redeems  all  worn  coins  at  their 

334 


CHAPTER  XII.     PRINCIPLES   OF  MONEY 

face  value,  a  coinage  in  active  use  always  shows  a  strong  tend- 
ency to  deterioration."     Explain  why  this  is  bound   to  be  true. 

11.  ''I  object  to  our  buying  outside  anything  which  we  can 
produce    at    home;    for    this    means    just    so    much    money    lost 
from  our  coin  circulation."     Show  that  this  is  unsound. 

12.  About  1850,  when  the  United  States  had  bimetallism  at  a 
ratio  of  16  to  1,  there  took  place  a  considerable  fall  in  the  silver 
price  of  gold,  so  that  the  silver  in  an  American  silver  Gonar  wa= 
worth  2  lo  3  cents  more  than  the  gold  in  a  gold  dollar.    In  con- 
sequence,  silver   coins   generally    went   out    of    circulation,    only 
the  much  worn  ones  remaining.     Explain    (a)    why  most  went 
out  and   (b)  why  some  stayed. 

13.  What  is  meant  by  saying  that  our  mint  ratio  between 
gold  and  silver  was  I  -to  15.98? 

14.  "New  York,  Dec.  11,   1903.     The  banks  gained  from  the 
interior  this  week  $2,042,906." — Newspaper.     Was  this  normal? 

15.  "London,     Oct.     3.     One    hundred     and    fifty    thousand 
pounds  sterling  gold  will  be  shipped  tomorrow  to  New  York." 
Was  this  normal? 


335 


CHAPTER  XIII. 
THE  PRESENT   SYSTEM   OF  DISTRIBUTION. 

It  is  a  fact  of  everyday  observation  that  the  economic  in- 
comes enjoyed  each  year  by  different  persons  or  families  are 
very  unequal  in  amount.  It  is  an  even  more  conspicuous  fact 
that  the  totals  of  accumulated  wealth  owned  by  different  persons 
or  families  are  very  unequal  in  amount.  This  inequality  of 
incomes  and  possessions  would,  like  any  other  notable  phenom- 
enon, demand  scientific  explanation,  even  if  no  great  human  in- 
terest were  involved.  But,  since  such  inequality  is  one  of  the 
most  trying  facts  of  actual  life,  its  study  and  discussion  inevitably 
becomes  of  quite  exceptional  interest  and  importance.  Accord- 
ingly, the  economist  has  in  every  generation,  and  in  ours  most 
of  all,  spent  much  time  trying  to  answer  questions  like  these: 
What  are  the  incomes  received  by  different  classes  of  persons? 
Under  what  general  and  specific  principles  are  these  incomes  at 
present  determined?  Is  the  general  result  entirely  reasonable  or 
just?  If  not,  what  is  to  be  said  for  and  against  the  various 
projects  brought  forward  to  improve  matters?  Such  questions 
as  these  suggest  pretty  fully  the  scope  of  that  division  of 
economics  commonly  known  as  Distribution.  In  the  present 
chapter  our  task  will  be  to  study  the  facts  of  the  existing 
system  of  distribution  and  the  principles  regulating  them. 

Section  A — The  Principal  Sources  or  Kinds  of  Incomes. 

Incomes  naturally  fall  into  two  main  classes,  (a)  Economic, 
and  (b)  Non-economic.  Under  the  former  are  included  all 
which  arise  directly  out  of  economic  activities ;  e.  g.,  wages  from 
the  sale  of  labor,  or  rent  from  selling  the  use  of  land.  Non- 
economic  incomes  are  all  those  which  arise  outside  economic 
activities ;  e.  g.,  from  gift  or  theft.  In  some  cases,  the  same 
income  can  be  with  more  or  less  reason  assigned  to  either  class. 
Thus,  many  of  the  great  incomes  obtained  in  America  from  the 
exploitation  of  natural  resources,  such  as  lumber,  copper,  oil, 
etc.,  which  may  be  classified  under  one  of  the  regular  economic 

33G 


Cl'  XIII.     SYSTEM   OF  DISTRIBUTION 

shares — profits, — may  also  be  conceived  as  in  a  sense  non-eco- 
romic  in  that  they  often  have  their  origin  in  the  foolish  or 
corrupt  munificence  of  government.  It  is  hardly  necessary  to 
say  that  our  study  of  incomes  will  be  largely  concerned  with 
those  which  can  properly  be  called  economic. 

The  economic  incomes  naturally  fall  into  two  classes:  per- 
sonal incomes,  i.  e.,  incomes  received  in  exchange  for  personal 
services  and  property  incomes,  i.  e.,  incomes  received  in  ex- 
change for  the  services  given  by  some  property  belonging  to 
the  receiver  of  the  income.  Practically  all  important  cases  of 
personal  income  may  be  brought  under  the  category  of  wages, 
though  in  ordinary  speech  remuneration  for  the  higher  forms  of 
personal  service  is  usually  called  salary.  Property  income  gives 
three  cases:  rent,  interest  and  profits. 

Rent,  as  commonly  understood  by  economists  and  as  used 
in  the  present  course,  does  not  correspond  to  the  popular 
usage,  which  makes  it  to  mean  the  hire  paid  for  the  use  during 
some  agreed  upon  period  of  any  material  object,  e.  g.,  a  house,  a 
piano,  a  boat,  etc.  Rather,  we  confine  it  to  hire  paid  for  the 
use  of  land.  Even  here  further  qualification  is  needed.  In  the 
strictest  sense,  rent  is  paid  for  the  use  of  non-producible  or 
anvbow  indestructible  elements  in  land.  No  doubt,  as  we  have 
often  had  occasion  to  say,  one  sometimes  has  difficulty  in  drawing 
lines  with  precision.  Whether  a  particular  element  in  a  par- 
ticular income  ought  to  be  included  under  rent  or  under  some 
other  category  can  not  always  be  determined.  But  practically 
no  great  difficulty  is  experienced  save  in  the  semi-metaphysical 
controversies  of  economists.  When  governments  set  about  tax- 
ing true  rents  while  letting  the  hire  of  capital  goods  such  as 
houses,  barns,  fences,  etc.,  go  free,  they  easily  reach  a  result 
accepted  by  the  public  as  substantially  fair. 

Interest,  we  remember,  is  the  capitalist's  remuneration  for 
waiting.  Its  purest  form  is  seen  in  loans  where  risks  are  prac- 
tically eliminated.  Profits,  on  the  other  hand,  are  the  remun- 
eration paid  specially  for  taking  the  risks,  or  better,  taking  the 
responsibilities  of  ownership* 

ILLUSTRATIVE  PROBLEMS. 

i.  In  later  years  many  city  governments  'have  introduced 
the  plan  of  putting  specially  heavy  taxes  on  economic  rent  or, 

*For  a   fuller   account   of  the   nature  of  profits  see   Section  H. 
337 


PRINCIPLES  OF  ECONOMICS 

what  amounts  to  the  same  thing,  on  the  value  of  sites. 

(a)  Do  you  see  any  way  of  distinguishing  the  value  of  the 
site  from  that  of  the  building? 

(b)  Show  that  taxing  the  value  of  the  site  would  naturally 
amount  to  taxing  the  economic  rent. 

2.  Mr.  Crane  puts  $3000  into  a  grocery  business  and  works 
himself   in   the   store   from   morning  till   night.     His  net  return 
from  the  business  is   $1500. 

Make  an  imaginary  distribution  of  this  income  into  the  sev- 
eral economic  shares  which  are  probably  involved. 

3.  My  friend  has  eight  houses  and  lots  in  Ann  Arbor  which 
he    rents,    getting    for    each,    let   us   say,   $360   a   year.     Try   to 
break  up   this   sum   into   the  different   elements   which   probably 
enter  into  it. 

4.  At  a  certain  inland  resort  rowboats  are  let  at  $1.50  per 
day.     Enumerate  the  different  elements   entering  into  this  sum. 

5.  The  following  are  among  the  chief  manifestations  of  the 
Interest  phenomenon.     Explain  and  illustrate  each  of  the  three 
cases  under  (b). 

(a)  In    loan    contracts.      People    borrowing    money    return 
an  equal  sum  and  also  something  additional, — a  bonus   or  pre- 
mium. 

(b)  In  the  determination  of  prices. 

(1)  Producible  goods   sell   for  prices  higher  than  their  cost  in 
other  goods  and  labor  would  seem  to  warrant. 

(2)  The  annual  uses  of  producible  goods  sell  for  prices  higher 
than  the  prices  of  the  goods  themselves  would  seem  to  warrant. 

(3)  Non-producible  goods   sell   for  prices  lower  than  the  sums 
of  the  prices  of  their  uses  would  seem  to  warrant. 

Section  B.    The  Influence  of  Legal  Arrangements  on  Dis- 
tribution. 

It  has  commonly  been  admitted  that  legal  conditions  play  a 
very  large  part  in  determining  the  distribution  of  incomes  and 
possessions.  The  point  is  so  evident  as  to  need  little  elabora- 
tion. Eor  example,  the  law  commonly  excludes  force  and  fraud, 
and  it  is  manifest  that  distribution  depends  not  a  little  on  the 
extent  to  which  these  restrictions  on  conduct  are  enforced.  So, 
the  law  determines  how  far  men  shall  be  free  to  give  away  or 
bequeath  property,  and  so  determines  in  no  small  measure  the 
size  of  incomes  having  such  origin.  Again  the  law  decides 
whether  private  individuals  shall  have  a  property  right  in  other 
men,  in  land,  in  capital  goods,  and  so  on;  and  the  decision 
reached  in  each  of  these  cases  has  a  great  influence  on  distri- 
bution. If  private  persons  were  prohibited  from  acquiring  and 

338 


CHAPTER  XIII.     SYSTEM  OF  DISTRIBUTION 

holding  the  title  to  land,  rent,  as  a  share  enjoyed  by  a  limited 
number  of  private  persons,  could  hardly  exist.  Similarly,  inter- 
est and  profits,  as  private  shares,  depend  on  the  right  of  private 
property  in  capital,  also  on  the  right  of  business  initiative,  on  the 
right  to  exchange  present  goods  for  future  goods  plus  a  bonus, 
and  so  on.  Still  again,  the  law  can  greatly  modify  distribution 
through  its  use  of  the  taxing  power.  The  burden  of  supporting 
the  state  may  all  be  thrown  on  the  wealthy  class,  or  on  a  lim- 
ited section  of  that  class,  e.g.,  the  landowners.  Further,  the 
state,  while  locating  the  burden  of  its  support  on  a  special  class, 
may  greatly  expand  its  activities  for  the  economic  benefit  of  some 
other  class  or  classes,  thus  in  effect  redistributing  incomes. 

ILLUSTRATIVE  PROBLEMS. 

1.  By  substituting  public  for  private  ownership  of  land,  the 
state  would  do  away  with  rent  as  a  private  income. 

(a)  Would  it  do  away  with  rent  altogether? 

(b)  Would  it  make  the  land  any  freer  than  it  is  today,  i.e., 
would  it  make  the  process  of  getting  hold  of  a  piece   of   land 
from  which   to   make  a   living  easier   or   cheaper   for  the  poor 
man? 

2.  Socialism  would  try  to  get  rid  of  interest  as  an  individual 
share.     Could  it  probably  annihilate  interest  altogether? 

3.  If  the  laboring  classes  were  in  a  condition  of  true  slav- 
ery, would  there  be  wages  in  the  strict  sense  of  the  word?     In 
any  sense  of  the  word? 

4.  ''After  the  tax   (land  tax)   has  been  in  froce  for  a  num- 
ber of  years,     *     *     *     it  ceases  to  impose  any  burden  whatever 
upon  the  present  landowners.     Hence  a  government  which  fails 
to  raise  the  rate  of  the  land  tax  every  few  years   discriminates 
in   favor  of  landowners." 

Give  the  argument  by  which  the  above  contention  is  sup- 
ported. 

5.  "The   use    of  indirect   taxes   to   raise   the    public    revenue 
exaggerates   the   inequalities   of   a   system   in    which    inequalities 
are  already  far  too  great;  for  such  taxes  rest  with  much  greater 
weight  on  the  poor  than  on  the  rich."    Explain  the  argument  for 
this  contention. 

Section  C.    General  Character  of  the  Process  whereby  the 
Regular  Economic  Shares  are  Determined. 

Generally  speaking,  the  process  whereby  the  regular. economic 
incomes — wages,  rent,  interest,  and  profits — are  determined  is  the 
price-determining  process.  In  other  words,  distribution  may 
quite  properly  be  conceived  as  only  a  subdivision  of  exchange, 

339 


PRINCIPLES  OF  ECONOMICS 

or  anyhow  as  regulated  by  the  laws  of  exchange.  The  correct- 
ness of  this  account  of  the  matter  is  easily  established  by  run- 
ning over  the  several  types  of  economic  income.  Thus  (a)  it  is 
manifest  that  wages  of  all  sorts  are  in  most  cases  nothing  but 
prices,  i.  e.,  the  prices  of  labor  services  brought  by  the  laborer 
to  market,  (b)  Interest  is  also  a  plain  case.  As  we  have  con- 
ceived it,  the  lender  makes  a  sale,  a  sale  of  the  service  of  wait- 
ing. In  that  way  of  putting  it,  interest  is  plainly  a  price.  If 
one  prefers  the  form  of  expression  which  describes  the  lending 
transaction  as  an  exchanging  of  present  for  future  goods  plus  a 
bonus,  we  still  make  the  case  one  of  exchange — and  so  of  values, 
(c)  Rent  is  obviously  the  price  of  something,  i.e.,  the  use  of 
land  unmodified  or  modified  only  by  improvements  which  are 
indestructible,  (d)  The  case  of  profits  is,  on  the  surface,  less 
evident;  but,  at  bottom,  it  is  not  materially  different.  The 
enterpreneur  supply  the  service  of  responsibility-taking.  From 
the  very  nature  of  this  service,  it  can  not  be  sold  directly;  but  it 
is  virtually  sold  in  tha*-  the  entrepreneur  unites  this  service  with 
the  services  which  he  buys  from  other  agents  in  the  productive 
processes  and  sells  the  total'  resultant  on  the  general  market. 
Profits,  therefore,  are  in  effect  a  price  received  for  a  service 
supplied. 

The  preceding  discussion  shows  that  incomes  are  directly 
determined  under  the  principles  of  exchange.  There  is  another 
less  direct,  but  not  unimportant,  sense  in  which  incomes  are  de- 
termined through  exchange  processes.  The  immediate  income 
which  most  of  us  get  is  an  income  of  money  or  its  equivalent. 
To  realize  our  income  we  turn  this  money  income  into  com- 
modities or  services  through  exchange.  But,  obviously,  the 
amount  of  the  latter  which  we  enjoy  must  depend  in  large 
measure  on  the  money  prices  of  these  commodities  and  services. 

Section  D.     The  General  Principle  Determining  the  Regular 
Economic  Incomes  under  Free  Competition. 

We  have  just  seen  that  the  regular  economic  incomes  are 
either  themselves  prices, — wages,  rent,  interest, — or  anyhow  are 
dependent  on  the  prices  of  other  things, — profits.  Further,  the 
student  has  probably  noted  already  that  the  incomes  in  question 
are  really  nothing  more  than  the  prices  or  values  of  those  ulti- 
mate goods  discussed  in  Section  A,  Chapter  X.  It  follows 
therefore,  that  the  principle  there  set  forth  as  determining  the 

340 


CHAPTER  XIII.    SYSTEM  OF  DISTRIBUTION 

values  of  the  ultimate  cost  goo,,.,  is  really  the  general  prin- 
ciple which  in  the  long  run  governs  the  regular  economic  in- 
comes. For  various  reasons  I  shall  here  present  the  principle 
in  slightly  modified  form. 

Principle. — Every  economic  income  tends  to  approximate  that 
quantity  of  goods  ivhich  constitutes  an  expression*  of  the  mar- 
ginal utility  (productivity)  to  people  at  large  of  the  actual  out- 
fut — when  competition  is  free,  the  natural  output — of  the  type 
of  service  rendered  by  the  receiver  of  said  income,  and  which 
also,  in  the  case  of  free  competition,  constitutes  an  expression 
of  the  net  marginal  disutility,  ariginal  or  derived,  involved  in 
furnishing  said  type  of  service. 

Explanatory  Comments. 

(a)  The  above  principle  is  really  a  compound  one,  in  that 
it    asserts    the    coincidence    of    income    both    with    the    marginal 
utility  and  the  marginal  disutility  attaching  to  trie  service  rendered. 
The    full   title   of  the   principle,    therefore,    would   naturally   be 
the  Utility-Disutility  Principle.     It  is  possible,  however,  to  treat 
the  two  parts  as  separate  principles;  and  this  is  perhaps  desir- 
able at  times  in  that  the  first  is  accepted  by  some  writers  who 
would  stick  at  the   second.     Again,  the   first  of  the  two  prin- 
ciples, the  utility  one,  is  more  often  designated  the  Productivity 
Principle,  because  of  the  fact  that  the  great  majority  of  ultimate 
services  are  devoted,  not  to  supplying  utilities  directly,  but  to  pro- 
ducing other  goods  which  supply  utilities  directly.     This  practice 
we  shall  usually  follow  whether  referring  to  the  principles  sep- 
arately or  jointly  considered.     That  is,   we  shall  speak  of  the 
Productivity  Principle,  also  of  the  Productivity-Disutility  Prin- 
ciple, though  not  binding  ourselves  to  exclude  references  to  the 
Utility  Principle. 

Another  designation  which  will  frequently  be  given  our  prin- 
ciple is:  The  Service- Value  Principle.  This  is  intended  to 
bring  out  the  fact  that,  according  to  the  principle,  each  person 
tends  to  receive  a  share  which  represents  the  value  of  his  serv- 
ice or  contribution. 

(b)  We  have  just   seen  that  the   formula  above   set   forth 
really  contains  two  principles  in  one.     It  should  further  be  noted 


*This  is  the  strictly  exact  method  of  stating  the  point;  but  it  is  too 
roundabout  for  practical  needs.  Hereafter  we  shall  usually  say  equals  or 
approximates  marginal  significance  or  utility. 

341 


PRINCIPLES  OF  ECONOMICS 

that  the  first  of  these  is  itself  compound.  It  says  that  each 
income  tends  to  approximate  the  marginal  productivity  of  the 
actual  output,  while,  under  free  competition,  it  'ends  to  approxi- 
mate the  marginal  productivity  of  the  natural  output.  Tl.at  is, 
shares  correspond  to  marginal  productivity  anyhow, — even  when 
monopoly  prevails — ;  but,  then,  this  is  the  marginal  productivity 
of  an  artificially  restricted  output  or  supply  U'  we  have  free 
competition,  the  marginal  productivity  involved  is  that  of  the 
natural  output — the  output  which  would  DC  expected  in  view  of 
the  disutilities  incurred. 

(c)  The  principle  does  not  say  that  tne  income  tends  to 
equal  the  marginal  significance  of  the  type  of  service  furnished, 
but  that  it  tends  to  approximate  that  sum.  That  is,  marginal 
utility  and  marginal  disutility  constitute  limits  within  which  the 
economic  shares  naturally  range.  They  can  not  be  above  mar- 
ginal utility  nor  below  marginal  disutility, — tht  former  is  the 
buyer's  maximum,  the  latter  is  the  seller's  minimum — ;  but  they 
do  not  necessarily  coincide  with  either.  Thus  (1)  even  in  the 
case  of  limited  stock  goods,  e.g.,  the  use  of  land,  where  cost 
plays  no  part,  value  is  fixed,  precisely  speaking,  not  at  marginal 
utility  but  at  some  point  ranging  from  marginal  utility  down  to 
but  not  including  the  first  sub-marginal  utility;  and,  if  these 
two  utilities  are  somewhat  widely  separated,  value  may  vary 
considerably  under  the  same  conditions  of  demand  and  supply. 
For  example,  let  us  suppose  that  there  are  12  sites  of  a  certain 
grade,  and  that  a  section  of  the  demand  schedule  for  the  use  ot 
these  sites  runs  as  follows:  7  wanted  at  $550  or  any  figure  De- 
low  ;  2  more  wanted  at  $520  or  any  figure  below ;  3  more  wanted 
at  $500  or  any  figure  below;  and  3  more  wanted  at  $440.  Under 
these  conditions  rent  could  be  $500  or  any  figure  down  to,  but 
not  including,  $440.  That  is,  rent  would  only  approximate  the 
marginal  utility,  not  equal  it.  Again,  (2)  in  the  case  ot  pro 
ducible  goods,  there  is  another  element  contributing  uncertainty. 
Cost  may  play  a  part.  If  the  marginal  cost  (disutility)  lies 
between  the  marginal  utility  and  the  first  submarginal  utility,  then 
the  value  or  price  may  be  anything  from  marginal  utility  down- 
to,  and  including,  marginal  cost.  And,  since  the  distance  be- 
tween them  might  be  considerable,  we  could  only  say  that  price 
must  tend  to  approximate  each.  (To  get  clearly  in  mind  this  case 
of  a  price  ranging  from  marginal  utility  down  to  marginal  cost, 
turn  to  problem  12,  p.  270.  Combine  output  schedule  A  with  the 

342 


CHAPTER  XIII.     SYSTEM  OF  DISTRIBUTION 

demand  schedule,  and  you  will  have  a  price  determined  in  the 
way  described,  save  that  in  Distribution  we  have  to  do  with 
disutility  costs  rather  than  with  money  costs.) 

(d)  The  principle  as  stated  teaches  that  each  tends  to  get 
the  sum  which  represents  the  marginal  significance  of  his  serv- 
ices.    It  is   possible   that  a  given   laborer   may  be   supplying  a 
service  for  which  the  buyer  would  be  willing  to  pay  $10,  though 
he  only  needs  to  pay  $2,  because  the  latter  sum  expresses  the 
marginal    utility    of    this    type    of    labor-service.      This    is,    of 
course,  the  same  principle  that  we  have  in  the  case  of  ordinary 
goods,  bread,  meat,  coffee,  and  so  on.     Whether  ethically  right 
or  wrong,  there  is  nothing  peculiar  about  it. 

(e)  In   the    second   part   of   our  principle,   it  was   said  that 
every   economic   income   tends   to   be    one    which    constitutes    an 
expression  of  the   net  marginal  disutility,  etc.     The  word  "net" 
was    introduced    to    provide    for    the    following    feature    of    the 
matter.    In   not   a    few   cases,   the   supplying  of  a   given   service 
involves  advantages  as  well  as  disutilities ;  e.g.,  university  teach- 
ing gives   men  opportunity   for  the  pursuit  of  scientific  investi- 
gations,  practicing   law   gives    men    standing   in   the    opinion    of 
their   fellows,   and  so  on.     Now.  it  is  evident  that,  in  cases  of 
this    sort,    the    reward    received    by   the    man    who    supplies   the 
service   does   not  need   to   be   large   enough   to   express   the    full 
disutility  of  his  task  but  only  large  enough  to  express  that  dis- 
utility  minus   the   incidental    advantages   of   the    calling. 

(f)  In   the    second   part   of   our   principle   it   was    said   that 
incomes  tend  to  approximate  the  marginal  disutility,  original  or 
derived,  etc.     By  an  original  disutility  we  mean  one  that  attaches 
to  the  supplying  of  some  service  by  the  very  nature  of  the  case, 
e.g.,   the   wearine*ss   and   pain,   which    from   the    first    accompany 
excessive  labor.    By  a  derived  disutility  we  mean  one  which  does 
not  belong  to  the  supplying  of  a  service  at  the  outset  but  comes 
to  attach  itself  to  said   supplying  of  a  service  because  of  later 
developments.      Here   we   have    in   mind   the   case    of    supplying 
land  services.     It  is  almost  self-evident  that  doing  this  does  not 
involve  an  original  disutility.     Originally  the  land  costs  nothing. 
Supplying  it  involves  in  the  first  instance  no  sacrifice.     But  this 
is  not   the  end   of  the  matter.     The   inevitable   working  of   the 
principles  of  value  develops  a  sacrifice  cost  for  supplying  land 
services.      When    through    the    growth    of    demand,    a    piece    of 

343 


PRINCIPLES  OF  ECONOMICS 

ground  hiti.'e-to  worthless,  comes  to  yield  a  net  income  of  $100, 
it  inevitably  takes  on  a  value  of,  say,  $2000;  so  that  any  person 
other  than  the  present  owner  who  should  desire  to  get  the  right 
to  this  $100  income  would  have  to  pay  for  suvh  right  $2000.  In 
short,  to  him  the  land  would  present  itself  as  so  much  capital 
goods  yielding  5  per  cent  as  a  payment  for  the  abstinence  or 
waiting  involved.  Here  we  have  sacrifices  which  are  necessarily 
undergone  in  connection  with  the  supplying  of  land  services, 
and  which,  therefore,  must  be  recognized  as  disutility  costs. 
Still  they,  obviously,  are  not  primary,  original,  costs  like  labor 
and  waiting,  but  only  secondary,  derivative,  costs. 

(g)  The  reader's  study  of  the  forces  and  processes  deter- 
mining normal  price  in  the  case  of  ordinary  goods  will  prob- 
ably safeguard  him  against  a  not  uncommon  misunderstanding  or 
misapplication  of  tbe  principle  before  us,  which  runs  like  this : 
''You  economists  are  always  teaching  that,  if  there  is  free 
bargaining  between  laborers  and  capitalists,  the  former  will  get 
all  they  produce."  In  answer,  I  hardly  need  say  that  it  is  not 
primarily  freedom  of  bargaining  between  laborers  and  capital- 
ists, but  rather  freedom  of  competition  among  capitalists  (entre- 
preneurs) which  we  expect  wrill  insure  that  laborers  get  sub- 
stantially what  they  produce. 

(h)  Finally,  it  must  not  be  supposed  that,  in  affirming  that 
the  present  system  tends  to  give  each  one  what  he  produces,  we 
mean  to  claim  that  the  present  system  is  necessanlv  a  just  one. 
Thus,  a  man's  power  to  contribute  to  the  social  welfare  depends 
on  his  right  to  dispose  not  only  of  his  own  services  but  also 
of  the  services  of  some  products  or  some  land  which  he  controls. 
But,  obviously,  it  may  be  wrong  to  allow  him  to  have  the  dis- 
posal of  the  services  of  products  and  land. 

Argument  for  the  General  Truth  of  the  Principle. 
As  was  brought  out  in  Section  A,  Chapter  X.,  the  problem 
now  before  us,  i.e.,  the  problem  as  to  how  the  regular  eco- 
nomic incomes  are  determined,  is  almost  identical  with  the  prob- 
lem treated  in  that  connection,  i.e.,  the  problem  as  to  how  the 
prices  of  the  ultimate  cost  goods  are  determined.  Further,  it  is 
hardly  necessary  to  say  that  the  solution  reached  for  our  earlier 
problem  is  substantially  identical  with  that  solution  of  our  pres- 
ent problem,  which  is  embodied  in  the  Productivity-Disutility 
Principle  just  set  forth  and  explained.  Accordingly,  it  would 

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CHAPTER  XIII.     SYSTEM  OF  DISTRIBUTION 

seem  legitimate  to  assume  that  our  principle  has  already  been 
established;  and  this  we  wilt  do,  although,  in  discussing  some- 
what more  fully  particular  incomes,  we  shall  probably  offer, 
incidentally,  some  further  defense  of  the  doctrine. 

Section  E.     Corollaries  of  the  Productivity  Principle. 

It  hardly  need  be  -explained  that  no  one,  in  affirming  the 
truth  of  the  Productivity  principle,  means  to  teach  that  it  is 
precisely  realized  in  the  phenomena  of  actual  life.  Few  con- 
tributors to  production  receive  sums  which  exactly  correspond 
to  their  contributions.  Some  get  much  more;  a  far  larger 
number  get  less.  But,  again,  it  is  hardly  necessary  to  say  that 
the  case  of  the  Productivity  principle  is  not  materially  different 
from  that  of  any  other  economic  law.  Those  hypotheses  which 
are  assumed  as  the  starting  point  of  all  economic  reasoning,  viz., 
absence  of  force,  fraud,  favoritism,  monopoly,  and  other  con- 
ditions interfering  with  freedom  of  competition  and  contract — 
are  far  from  being  realized.  Further,  were  none  of  these  man- 
ifestly abnormal  elements  present,  we  should  still  have  human 
ignorance,  folly,  inertia,  and  so  on,  to  hinder  any  precise  real- 
ization of  the  economic  principle  under  consideration,  as  in  fact 
of  any  other  economic  principle.  But,  while  the  principles  of 
economic  science  are  nowhere  rigidly  operative,  they  are  so  far 
dominant  that  they  can  not  in  practical  affairs  be  safely  ignored. 
Looked  at  broadly,  economic  phenomena  are  under  their  control. 
While  this  statement  is  more  conspicuously  true  of  some  other 
economic  principles  than  of  the  one  before  us,  still,  it  applies 
to  this  one  also.  Not  a  few  well-meant  but  ill-directed  reforms 
have  been  thwarted  because  of  a  disregarding  of  this  principle. 
This  point,  however,  is  best  brought  out  by  presenting  some 
corollaries. 

Corollary  1.  Attempts  to  fix  arbitrarily  the  amount  of  any 
economic  share  whether  by  governmental  or  private  action  with- 
out changing  the  demand  for,  or  the  supply  of,  the  particular 
type  of  service  involved  can  succeed  only  within  the  narrowed 
limits. 

Illustrations  of  such  attempts:  Statute  of  Laborers  (1351),  to 
keep  wages  at  the  old  level  in  spite  of  the  diminution  of  labor- 
ers through  the  black  death ;  minimum  wage  laws ;  usury  laws. 

Note  that  the  attempts  which  the  corollary  deals  with  are 
attempts  arbitrarily  to  regulate  the  value  of  something  without 

345 


PRINCIPLES  OF  ECONOMICS 

changing  demand  or  supply.  It  is  at  times  possible  arbitrarily  to 
change  prices,  but  only  on  condition  that  one  accepts  the  con- 
sequences in  the  shape  of  changed  demand  or  supply.  Thus,  a 
monopolist  may  arbitrarily  raise  his  price,  but  only  on  condi- 
tion that  he  reconciles  himself  to  smaller  sales.  So  the  work- 
men in  a  particularly  trade,  if  very  strongly  organized,  ma./ 
put  up  the  wages  of  their  trade,  but  at  the  same  time  they 
must  be  content  with  fewer  jobs.  So,  again,  if  government  in-> 
sists  on  establishing  a  maximum  price  for  some  producible  serv- 
ice below  the  cost  of  supplying  that  service,  it  will  have  to  be 
satisfied  with  seeing  the  supply  of  said  service  fall  off.  If  in 
any  particular  case  the  action  taken  to  fix  prices  can  not  altei 
demand  and  supply  conditions,  it  can  seldom  succeed  at  all. 

Argument.  The  corollary  before  us  really  contains  two 
elements:  (1)  An  admission  that  the  shares  can  be,  in  some 
degree,  fixed  arbitrarily  by  legislation,  and  (2)  A  claim  that 
this  is  possible  only  within  very  narrow  limits.  Let  us  begin 
with  the  first  point. 

A.  Some  arbitrary  fixing  of  the  shares  is  possible.  (1)  A 
share  can  always  be  fixed  within  the  limits  set  by  the  Produc- 
tivity-Disutility Principle,  as  against  any  fixing  of  it  at  a  point 
outside  those  limits  because  of  a  failure  of  competition  or  the 
intervention  of  any  illegitimate  element.  For  example,  rent  is 
not  seldom  driven  above  marginal  productivity  because  of  the 
ignorance  or  inertia  of  tenants;  and  government  can  bring  it 
down  to  the  proper  level  without  colliding  with  regular  eco- 
nomic forces.  (2)  It  is  probable  that  there  is  nearly  always 
some  leeway  between  the  marginal  utility  and  the  first  sub- 
marginal  one  and  between  the  marginal  disutility  and  the  first 
supra-marginal  one,  i.e.,  our  principle  fixes,  not  the  precise  amount 
of  each  share,  but  omy  the  limits  within  which  it  may  range. 
But  one  point  within  these  limits  will  reconcile  supply  and 
demand  as  'well  as  another.  Hence  within  these  limits,  legisla- 
tion can  arbitrarily  fix  on  one  oar*1  ular  point  rather  than 
another  without  coming  into  collision  with  regular  economic 
forces.  For  example,  if  wages  anyvvhe.  <?  from  $1.20  to  $1.40 
would  reconcile  demand  and  supply  the  Uw  might  fix  them  at 
$1.40  without  contravening  our  principle  r.t  all.  (3)  It  is  ad- 
mitted that  the  prices  of  labor  services  or  capital  services  or 
iand  services  can  be  fixed  at  points  somewhat  outside  the  limits 
set  by  the  Productivity-Disutility  principle  because  of  the  inertia 
or  weakness  of  buyers  or  sellers  of  those  services.  But,  this 
being  true,  it  is  surely  reasonable  to  claim  that  government, 
when  public  policy  demands  it,  can  take  advantage  of  similar 

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CHAPTER  XIII.    SYSTEM  OF  DISTRIBUTION 

weaknesses  consciously  to  fix  prices  somewhat  outside  the  limits 
fixed  by  our  principle. 

B.  Such  arbitrary  fixing  of  the  economic  shares  is  possible 
only  within  very  narrow  limits.  (1)  Law  can  not  long  compel 
people  to  pay  for  anything  more, — anyhow  much  more, — than  it 
is  worth  to  them.  (2)  Law  can  not  long  hinder  people  from 
paying  for  anything  as  much, — anyhow  almost  as  much, — as  it  is 
worth  to  the  marginal  buyer ;  for  this  is  the  only  way  to  insure 
that  buyers  at  or  within  the  margin  will  get  the  goods,  as  against 
buyers  outside  the  margin.  (3)  Law  can  not  long  compel  people 
to  furnish  anything  for  a  price  much  below  that  which  expresses 
to  them  the  disutility  incurred  in  furnishing  that  thing.  (4)  Law 
can  not  long  hinder  people  from  taking  a  price  for  some  serv- 
ices substantially  as  low  as  that  one  which  expresses  the  dis- 
utility incurred  in  furnishing  said  service. 

Corollary  2.  Broadly  speaking,  the  share  per  unit  of  each 
class  of  producing  agencies  varies  inversely  as  the  size  of  that 
class. 

Abundant  land  makes  rent  low;  abundant  capital  makes 
interest  low;  abundant  labor  makes  wages  low.  This  obviously 
results  from  the  joint  action  of  the  principle  of  productivity  and 
the  law  of  diminishing  returns.  Each  productive  agent  tends  to 
get  an  amount  equal  in  value  to  what  the  marginal  member  of 
his  class  produces.  But,  since  the  larger  his  class  the  smaller 
will  be  the  product  of  the  marginal  member,  therefore  the 
larger  his  class  the  smaller  the  income  which  each  member  gets. 

Caution  : — Remember  that  every  scientific  principle  assumes 
continuity  of  conditions.  An  increase  in  the  volume  of  capital 
would  not  necessarily  lower  the  rate  of  interest  if  accompanied 
by  the  introduction  of  new  and  more  efficient  methods  of  em- 
ploying that  capital. 

Corollary  3.  Broadly  speaking,  the  share  per  unit  of  each 
class  of  producing  agencies  varies  directly  as  the  si"e  of  other 
classes  which  co-operate  with  it. 

If  capital  increases  in  volume,  not  only  does  the  rate  of  re- 
turn to  capital  tend  to  fall,  it  is  equally  true  that  the  rate  of 
return  to  labor  and  land  also  tends  to  rise. 

Argument.  A.  That  increasing  the  size  of  one  class  increases 
the  share  of  the  others.  (1)  According  to  the  last  corollary, 
the  condition  supposed  lowers  the  rate  of  return  to  the  chang- 
ing factor.  (2)  Since  the  total  going  to  said  changing  factor 

347 


PRINCIPLES  OF  ECONOMICS 

out  of  the  product  of  earlier  units  of  the  combination  is  fixed 
by  multiplying  the  number  of  units  into  the  rate,  said  total  will 
be  smaller  than  before.  (3)  In  consequence  the  portion  of  the 
product  of  earlier  units  going  to  the  other  factors,  being  that 
product  minus  the  total  going  to  the  changing  factor,  will  be 
larger  than  before.  Illustration:  Ignoring  capital,  let  us  sup- 
pose that  a  certain  piece  of  land  will  yield  to  one  man's  labor 
14  bushels  of  wheat;  to  the  labor  of  two  men,  20  bushels;  to 
that  of  three  men,  24  bushels;  and  to  that  of  four  men,  26 
bushels.  When,  now,  laborers  are  so  few  that  land  needs  to  be 
worked  in  the  first  stage  only,  the  whole  product,  14  bushels, 
will  go  to  labor.  When  it  becomes  necessary  to  put  on  a 
second  man,  he  will  add  only  6  bushels,  therefore  will  get  only 
6  bushels,  and  the  first  man  also  will  get  only  6  bushels,  thus 
giving  the  landlord  20  minus  12  or  8  bushels  rent.  So  when  a 
third  man  has  to  go  on,  his  product  and  share  will  be  4  bushels ; 
the  shares  of  laborers  1  and  2  will  fall  to  the  same  figure,  and 
the  total  of  the  landlord  will  become  24  minus  12,  or  12  bushels. 
Thus,  increasing  the  number  of  laborers  lowers  their  share  and 
raises  that  of  the  landlord. 

B.  That  diminishing  the  size  of  one  class  diminishes  the 
shares  of  the  others.  Here  the  proof  merely  reverses  the 
preceding.  Let  the  student  work  it  out  for  himself. 

Corollary  4.  Increase  of  population  in  itself  tends  to  lower 
all  shares  but  rent,  most  of  all  common  wages. 

This  is  an  evident  corollary  from  the  preceding  proposition. 
Increasing  population  means,  in  general,  lowering  the  margin 
of  industry,  bringing  into  use  lower  grades  of  land;  since  land 
as  such  is  non-increasable.  Hence  the  marginal  return  to  land 
i.  e.,  the  portion  of  the  total  which  goes  to  the  human  factors 
in  production,  labor,  waiting,  and  risk-taking  must,  in  the 
absence  of  new  conditions,  tend  to  decline.  The  lowering 
tendency  is  greatest  in  the  case  of  wages,  since  a  normal 
increase  in  population  tends  to  increase  the  supply  of  labor 
more  than  that  of  waiting  or  risk-taking. 

Note  1 : — It  is  sometimes  argued  that  increase  in  population 
does  not  lower  wages  for  the  reason  that  each  person  brings 
into  the  world  capacity  to  produce  as  well  as  capacity  to  con- 
sume. He  adds,  therefore,  to  the  supply  of  goods  just  as  much 
as  to  the  demand.  This  merely  shows  that  there  is  not  ordin- 
arily any  danger  that  the  new  laborer  will  be  unable  to  get 
any  wages  at  all.  It  does  not  show  that  he  will  be  able  to 

348 


-CHAPTER  XIII.    SYSTEM  OF  DISTRIBUTION 

get  as  high  wages  as  before.  Since  the  stock  of  natural  factors 
in  production  and  the  stock  of  capital  are  not  increased  by 
the  incoming  of  the  new  laborers,  therefore  the  marginal 
productivity  of  labor,  and  with  it  the  \ 'ages  of  labor,  must 
tend  to  be  lowered. 

Note  2  : — It  is  sometimes  argued  that  increase  in  population, 
in  that  it  makes  a  larger  market  and  so  justifies  the  resort  to 
extreme  specialization,  large  scale  production,  etc.,  really  raises 
marginal  productivity  rather  than  lowering  it,  and  so  raises 
the  shares  going  to  labor  and  capital.  This  is  doubtless 
possible,  but  not  in  my  opinion,  probable.  In  most  countries 
population  has  long  since  reached  the  size  which  would  justify 
a  resort  to  the  most  efficient  methods.  If  a  particular  community 
is  failing  to  take  advantage  of  the  possibilities  of  large-scale 
production  because  markets  are  too  small  to  justify  a  resort 
to  that  method,  this  smallness  of  the  markets  is  probably  not 
due  to  the  lack  of  the  population  necessary  to  make  a  large 
market,  but  to  the  lack  of  those  facilities  for  transportation 
and  communication  in  general  which  are  necessary  to  coalesce 
the  different  small  markets  into  one  large  one. 

Corollary  5.  Any  cause  which  restricts  competition  among 
the  persons  who  supply  a  particular  type  of  service  tends  to 
increase  the  rate  of  income  received  by  the  said  persons. 

It  is  of  course  a  fact  familiar  to  the  student  that  producers 
in  all  lines-  are  disposed  to  adopt  measures  to  limit  competition, 
each  in  his  particular  line.  Monopoly  in  some  form  or  degree 
is  a  condition  of  things  which  consciously  or  unconsciously 
almost  every  one  tries  to  see  realized  in  his  special  field.  Per- 
haps the  entrepreneurs  in  some  industry,  e.  g.,  sugar  produc- 
tion, form  a  trust,  thus  establishing  a  combination  so  wide- 
reaching  as  to  approximate  monopoly.  Or  perhaps  the  men 
engaged  in  building  houses  in  a  particular  city  form  an  agree- 
ment whereby  they  promise  not  to  compete  in  the  fullest  sense 
against  each  other.  Or  perhaps  the  painters  combine  to  restrict 
their  numbers  by  refusing  to  take  on  more  than  a  fixed  num- 
ber of  apprentices  at  any  one  time.  Now,  it  is  doubtless  hoped 
in  each  of  these  cases  that  the  action  described  will  increase 
the  returns  to  the  persons  interested;  the  entrepreneurs  in 
sugar  and  the  contractors  will  get  larger  profits,  and  the  work- 
men in  the  case  of  painting  will  get  larger  wages.  .  Further  it 
is  doubtless  true  that  the  result  thus  hoped  for  is  largely  realized. 
Such  restrictions  of  competition  do  usually  increase  the  incomes 
of  the  persons  interested.  The  reasons  are  plain.  Diminished 
competition  means  decreased  output,  therefore  higher  marginal 
productivity  or  utility,  therefore  higher  price  for  the  service 

349 


PRINCIPLES  OF  ECONOMICS 

involved.  The  principle  as  stated  says  "rate  of  income"  rather 
than  simply  "income"  in  order  to  provide  for  cases  where  re- 
stricting of  output  might  increase  the  return  per  unit  of  service 
performed  but  not  per  person.  Thus,  the  whole  body  of  labor- 
ers might  unite  to  keep  say  one-fifth  of  their  number  idle, 
hoping  thereby  to  increase  the  total  income  of  their  class* ; 
while  in  fact  they  might  thereby  lower  the  total  though  increas- 
ing the  rate,  i.  e.,  the  income  per  unit  of  service  or  effort. 

Corollary  6.  Any  cause  which  restricts  competition  among 
the  persons  who  supply  a  particular  sub-class  of  services  tends 
to  lower  the  incomes  of  the  persons  who  supply  related  sub- 
classes of  services. 

Example.  Restricting  competition  among  painters  tends  to 
lower  the  wages  in  inferior  trades. 

As  we  have  seen,  it  is  very  common  to  try  to  limit  the  out- 
put of  one's  own  type  of  service  in  order  thereby  to  raise  the 
price  of  it.  It  is  less  common,  but  by  no  means  rare,  to  hear 
persons  who  have  inaugurated  this  policy  attempting  to  enlist 
the  sympathy  and  support  of  others  as  if  the  public  in  general 
or  producers  in  general  were  to  gain  by  it.  That  persons  some- 
times succeed  in  this  attempt  does  not  alter  the  facts  of  the 
case  Their  position  is,  generally  speaking,  quite  untenable. 
We  may  sympathize  with  their  aims,  may  even  be  glad  to  suffer 
some  loss  in  helping  them  to  realize  those  aims;  but  we  are 
bound  to '  experience  a  loss — the  policy  in  question  is  against 
the  immediate  economic  interests  of  all  but  the  persons  directly 
concerned. 

Argument.  Restricting  competition  within  any  sub-class  of 
productive  agencies  drives  the  persons  shut  out  of  that  sub-class 
into  related  sub-classes,  thereby  increasing  the  size  of  said  sub- 
classes. As  a  consequence,  under  the  working  of  Corollary  2, 
the  share  per  unit  of  those  classes  is  lowered. 

Corollary  7,  Broadly  speaking,  improvements  in  method 
through  discovery  and  invention  tend  more  especially  to  increase 
interest  and  profits. 

Such    improvements    increase    the    marginal    productivity    of 


*It  probably  can  be  shown  that  as  a  mere  matter  of  economic  theory, 
this  is  a  possible  result.  It  does  not,  however,  seem  of  sufficient  importance 
to  reward  the  effort.  I  will  perhaps  insert  a  discussion  of  the  matter  in 
the  next  edition  of  the  Readings. 

350 


CHAPTER  XIII.     SYSTEM   OF  DISTRIBUTION 

waiting    and    risk-taking,    and    so    fulfill    the    conditions    of    the 
Principle. 

Note : — This  is  not  to  say  that  improvements  in  method 
bring  no  advantage  to  laborers; — but  this  advantage  comes 
indirectly  in  lowered  prices  and  so  larger  real  wages. 

Corollary  8.  The  normal  income  for  a  laborer  of  any  partic- 
ular class  tends  to  approximate  the  income  needed  to  maintain 
said  laborer  in  accord  with  the  standard  of  lining  looked  upon 
as  necessary  by  this  particular  class  of  persons  in  the  particular 
time  and  place. 

Note  1.  This  principle  is  commonly  stated  as  if  applicable 
only  to  men  who  labor  with  their  hands,  or  even,  among  these, 
only  to  the  lower  or  lowest  types.  In  fact,  it  is  true  of  all 
classes,  even  professional  people. 

Note  2.  As  applied  to  common  workmen,  this  principle 
should  be  sharply  distinguished  from  the  "iron  law  of  wages" 
commonly,  but  erroneously,  attributed  to  the  classical  economists. 
That  theory  affirms  that  the  wages  of  common  laborers  tend  to 
equal  the  bare  or  necessary  cost  of  subsistence, — no  allowance 
being  made  for  what  people  look  on  as  necessary  to  a  decent 
living. 

Argument.  A.  The  case  of  the  professions  and  other  types 
of  labor  above  the  lowest.  (1)  An  income  below  the  standard 
of  living  income  can  not  be  maintained;  because  persons  in 
these  classes  have  always  as  an  alternative  dropping  into  some 
lower  class.  This  they  will  do  if  incomes  fall  below  the  recog- 
nized standard, — with  the  result  that  the  supply  of  the  services 
involved  will  fall  off,  their  marginal  utility  will  rise,  and  so  their 
price  will  rise.  (2)  An  income  materially  above  the  standard 
can  not  long  be  maintained,  because  it  will  cause  an  influx  from 
o^her  closely  related  callings,  which  will  lower  marginal  utility 
and  so  lower  price  (wages). 

B.  The  case  of  common  labor.  (1)  An  income  below 
the  standard  can  not  permanently  be  maintained,  because  it  will 
hinder  marriage,  hence  cut  down  the  supply  of  labor,  therefore 
raise  its  marginal  utility  and  so  its  price.  (2)  An  income  above 
the  standard  will,  of  course,  tend  to  have  the  opposite  effect, 
increasing  population,  lowering  marginal  utility,  and  so  lowering 
wages. 

Comment.  It  is  an  evident  deduction  from  the  corollary  be- 
fore us  that  in  the  long  run,  the  rate  of  wages  can  be  changed 
by  changing  the  ideals  of  working  men.  But  it  hardly  need  be 
remarked  that  emphasis  must  be  laid  on  the  phrase  "in  the  long 
run."  Of  course,  it  is  not  possible  for  a  particular  generation 


PRINCIPLES  OF  ECONOMICS 


of  laborers  to  raise  wages,  if  these  are  already  as  high  as  the 
marginal  productivity  of  labor,  simply  by  resolving  to  live  better, 
to  spend  more.  The  setting  of  a  higher  standard  of  living  can 
influence  wages  only  in  so  far  as  it  restricts  population  and,  so, 
raises  the  marginal  productivity  of^  labor.  It  naturally  follows 
from  what  has  just  been  said,  and  it  has  always  been  recognized 
by  economists  that  it  is  possible  for  adverse  conditions  to  hold 
actual  wages  below  the  standard  until  the  working  classes  in- 
sensibly come  to  accept  this  lower  wage  level  as  a  new  standard. 
On  the  other  hand,  favorable  circumstances  may  work  the  op- 
posite result.  In  short,  a  new  level  of  wages  brought  about,  and 
for  some  time  maintained,  by  temporary  causes  tends  to  persist. 
(Well  treated  by  Malthus,  McCulloch,  and  Walker.) 

ILLUSTRATIVE  PROBLEMS. 

1.  The   following  table  contains  corresponding  sections   from 
hypothetical  output  and  demand  schedules  of  a  certain  type  of 
labor.     On  the  basis  of  this  table,  answer  the  questions  follow- 
ing: 

Utility  (or)  (a)    What    would    wages    per 

Output       Disutility  Demand  hour  tend  to  be? 

hours            cents  hours  (b)     How    much    is    marginal 

700                  40  100  utility?  average  utility? 

400                  35  120  (c)    What    do    you    mean    by 

280                  30  140  marginal  utility  in  this  case? 

200                  25  200  (d)     How    much    is    marginal 

140                  22  250  cost  or  disutility?  average  cost? 

120                  20  400  (e)  What  is  meant  by  marginal 

100                   18  500  cc  st  or  disutility  here? 

80                  15  800  (f)   Which  determines  wages? 

Why  do  you  think  so? 

2.  Suppose  the  schedules  in  Problem  1  be  changed  to  read  as 
follows : 

(a)  What    different    rates    of 
wages   might  prevail? 

(b)  What  would  be  the  margi- 
nal utility  of  labor  under  each? 

(c)  What  the  marginal  disutil- 
ity? 

(d)What  would  fix  the  limits 
of  variation? 

(e)  By    what    process    would 
the  rate  be  finall}r  determined? 

(f)  Change  the  demand  figure 
at  25  and  24  cents  from  240  to 
200,  and  answer  questions  (a) 
to  (e). 

(g)  Change   the   output   at  29 
cents     from    200    to    280,    and 
answer   Questions    (a)    to    (e). 


Output 
hours 

280 
280 
280 
200 
200 
200 
200 
200 
150 
150 


Utility  (or) 
Disutility 
cents 

Demand 
hours 

32 

170 

31 

170 

30 

170 

29 

200 

28 

200 

27 

200 

26 

200 

25 

240 

24 

240 

23 

240 

352 


CHAPTER  XIII.     SYSTEM  OF  DISTRIBUTION 

3.  If  competition  were  in  the  highest  degree  free,  which  of 
the  above  schedules,  that  of   Problem   1   or  that  of   Problem  2, 
would  more  probably  express  the  facts  of  life?     Give  reasons. 

4.  Suppose  that  at  a  certain  date,  competition  being  free  and 
general  conditions  normal,  the  rate  of  wages  for  ordinary  labor 
is  $1.50  per  day;  and  suppose,  further,  that,  under  these  condi- 
tions,  the   legislature  passes  a  law   forbidding  any  one  to  pa> 
or  receive  wages  less  than  $5  per  day. 

Do  your  believe  that  this  would  result  in  giving  every  one 
wages  of  $5  per  day?  Why? 

5.  "The  logic  of  their  (the  orthodox  economists')    teaching, 
has  been  that  wages  which  were  determined  by  free  bargaining 
between  capital  and  labor  would  be  just  or  reasonable   wages." 

Point  out  wherein  the  above  is  incorrect,  or  at  least  inade- 
quate, as  a  statement  of  the  real  teaching  of  the  economists. 

6.  "In   a   country   possessed    of    rich   and   abundant   natural 
resources   wages   would   naturally    be    higher    than    in    another 
having    an    equal    population    but    inferior    natural    resources." 
Argue  this  out  fully. 

7.  "Wages  are  apt  to  be  fixed  much  closer  to  the  minimum 
which  the  laborer  will  take  than  the  maximum  which  the  em- 
ployer will  pay ;  for  the  latter  has  much  more  skill  and  strength 
in  bargaining." 

Perhaps  the  above  is  true;  but  the  argument  given  to  prove 
it  is  by  no  means  decisive.  It  is  quite  possible  that  wages  should 
be  kept  close  to  the  employer's  maximum  in  spite  of  the  laborer's 
weakness  in  bargaining  because  the  first  extra-marginal  utility  is 
close  to  the  employer's  maximum.  Explain  just  what  this  means 
and  how  it  can  be  true, — constructing  fur  the  purpose  schedules 
something  like  those  which  appear  in  Problems  1  and  2. 

8.  Suppose  that  a  certain  country  receives  a  large  body  of 
immigrants,  amounting  to,  say,  twenty  per  cent  of  its  laborers  of 
a  particular  class. 

(a)  Under  the  principle  of  productivity,  what  would  tend  to 
be  the  effect  on  wages?     Explain. 

(b)  If  these  immigrants  brought  in   knowledge  and  skill   in 
their   craft    far    beyond    that   possessed    by    the    home    laborers, 
how   would  this  immigration   tend   to  affect  wages   in  the   long 
run  ?     Explain. 

9.  Below    is    given    a    section    of    a    schedule    assumed    to 
represent  the  supply  and  demand  schedule  for  the  use  of  capital: 


Sm 

4.1  bill 
4 
3.9 
3.8 
3.7 
3.6 

). 
ions 

Price 
10% 
9% 
8% 

7% 
6% 
5% 

Dem. 

3     billions 
3.5 
4 
4.5 
5 
5.5 

353 


PRINCIPLES  OF  ECONOMICS 

(a)  What  will  tend  to  be  the  rate  of  interest  in  this  case? 

(b)  What  will  set  the  limits  to  price  variation? 

(c)  Is  it  likely  that  a  usury  law  fixing  the  rate  of  interest 
at  5  per  cent  would  be  effective?     Why  do  you  think  so? 

10.  What  bearing  does  Corollary  8  of  our  principle  have  on 
the    question    whether    Chinese    immigration    should,    or    should 
not,  be  discouraged? 

11.  Give  some  reasons  for  expecting  that,  under  the  natural 
working  of  the  Productivity-Disutility  principle,  the  incomes  of 
university  professors  would  be  smaller  than  those  of  men  hav- 
ing no   greater   natural   endowment   who   are   working   in   other 
fields,  say  engineering,  law,  or  business. 

12.  Discuss  in  a  similar  way  the  question  why  the  wages  of 
men   are   likely   to   be   higher   than   those   of   women   in   similar 
lines. 

13.  What  connection  is  there  between  the  Law  of  Diminish- 
ing Returns  and  the  contention  of  many  writers  that  conscious 
restraint  should  be  placed  on  the  growth  of  population? 

14.  "Formerly    the    workman    owned    the    instruments    with 
which  he  worked.     To-day  these  instruments  are  all  owned  by 
another  class — the   capitalists.     Now,   since  without  instruments 
the  workman's  labor-power  is  useless,  he  is  obliged  to  accept  such 
wages  as  the  capitalist  may  dictate  even  though  these  are   far 
below  what  his  labor  produces." 

(a)  Show  that  the  ownership  of  the  instruments  of  industry 
by  a  class  different  from  the  users  of  those  instruments  does  not 
of  itself  lead  to  the  result  indicated. 

(b)  Write  out  an  analogue  to  the  above  quotation  in  which 
the  capitalist  and  workman  change  places. 

15.  Why  is  it  to  be  expected  that  wages  would  be  higher  in 
the  United  States  than  in  Europe?    Argue  the  matter  out  on  the 
basis  of  principles. 

16.  Suppose  that  by  the  draining  of  swamp  lands,  one-fifth 
should  be  added  to  the  tillable  soil  of  the  country.     What  effect 
would    it  tend   to   have   on   wages?    on   profits?    on   agricultural 
rent?    Explain  in  each  case. 

17.  Suppose  that  land  and  labor  of  just  one  kind  were  the 
only    factors   in   production,   that   land   was   of    different   grades 
shading  one  into  another,  that  not  all  the  land  in  existence  was 
under  cultivation,  and  that  wheat  raising  was  the  only  industry. 
Show  that  wages  would  tend  to  equal  the  marginal  product  of 
labor. 

18.  It  was  generally  held  by  the  economists  of  the  so-called 
classical  school  that,  if  the  methods  of  production  undergo  no 
substantial  change  while  population  keeps  on  increasing,  wages, 
interest,  and  profits  will  tend  to  get  smaller  and  smaller  and  rent 
(economic  rent)   to  get  larger  and  larger. 

354 


CHAPTER  XIII.     SYSTEM  OF  DISTRIBUTION 

Show  that  'this  doctrine  is  a  natural  deduction  from  the 
theory  •  that  the  shares  of  labor,  waiting,  and  responsibility- 
taking  are  determined  by  their  respective  marginal  productivities. 

19.  "It  is  a  mistake  to  suppose  that  competition  merely  keeps 
down  wages.     It  is  equally  the  means  by  which  they  are   kept 
up."     Mill.     Explain. 

20.  "No  remedies  for  low  wages  have  the  smallest  chance  of 
being  efficacious,  which  do  not  operate  on  and  through  the  minds 
and  habits  of  the  people."     Mill. 

Argue  for  the  truth  of  this  statement.  (It  probably  needs 
qualification;  but  leave  that  for  some  other  occasion.) 

Section  F.     The  Theory  of  Employment. 

In  dealing  with  labor's  share  in  distribution  it  has  been  usual 
to  approach  some  of  its  problems  from  the  standpoint  of  employ- 
ment. How  far  this  procedure  is  really  profitable  one  can  not 
easily  decide ;  but  in  view  of  popular  usage  it  seems  best  to 
give  this  phase  of  the  matter  some  consideration. 

1.     Employment  and  the  Demand  for  Goods. 

Immediately,  of  course,  labor  is  bought  by  enterpreneurs ;  and 
so,  in  a  sense,  the  amount  of  employment  depends  on  the  demand 
of  entrepreneurs.  But  it  is  obvious  that  entrepreneurs  do  not 
want  labor  save  as  they  intend  to  produce  goods  with  it  and  that 
they  are  not  going  to  produce  goods  save  as  the  public  demand 
them.  Less  immediately,  therefore,  the  demand  of  entrepreneurs 
for  labor — the  amount  of  employment — is  in  some  degree  or  sense 
determined  by  the  public's  demand  for  goods.  But  the  public's 
demand  for  goods  is,  in  the  last  analysis,  dependent  on  their 
output  of  goods.  (Say's  Law).  Only  by  producing  goods  can 
we  create  a  demand  for  the  goods  which  other  producers  get 
out  and,  therefore,  only  by  this  process  can  we  create  a  demand 
for  the  labor  of  the  workmen  who  assist  those  other  producers 
in  getting  out  said  goods. 

Principle.  In  so  far  as  employment  depends  on  the  demand 
for  products,  it  change?  with,  and  only  with,  the  output  of 
products  for  the  market. 

Some  of  the  most  important  applications  of  this  principle 
were  brought  out  in  the  problems  given  under  Say's  Law  (pp. 
148-149),  our  present  discussion  of  them,  therefore,  will  be  brief, 
brief. 

Corollary  1.    The  destruction  of  objects  of  wealth  which  are 

355 


PRINCIPLES  OF  ECONOMICS 

bound  to  be  replaced  does  not  increase  employment.     See  Read- 
ing XII.' 

Corollary  2.  Private  expenditure  for  extravagances,  as  con- 
trasted with  other  forms  of  .expenditure  or  even  zvitli  hoarding, 
does  not  increase  employment. 

Argument:  (a)  $10,000  spent  in  buying  bread  or  cotton  cloth 
contributes  just  as  much  to  make  a  demand  for  labor  as  $10,000 
spent  in  buying  fireworks  or  champagne. 

(b)  $10,000  spent  in  buying  500  ounces  of  gold  coin  to  bury 
in  the  ground  coneributes  to  the  demand  for  labor  just  as  much 
as  $10,000  spent  on  gold  for  plate. 

Note  1.  It  is  possible  to  maintain  that  some  forms  of  ex- 
penditure give  more  employment  than  others,  since  labor,  &s 
compared  with  capital  and  land,  plays  a  larger  part  in  some 
forms  of  Droduction  than  in  others.  But  economists  have  with 
practical  unanimity  held  that  expenditures  for  extravagances 
contribute  less  to  create  employment  than  expenditure  for  c?pital 
goods, — producers'  goods — e.g.,  engines,  machinery,  etc. 

Note  2.  The  case  of  hoarding  brought  out  in  the  theorem 
has  merely  theoretic  interest.  Practically,  true  hoarding  is  in 
our  day  a  negligible  phenomenon.  The  rich  man  spends  nis 
money  (or  lends  it  to  some  one  who  spends  it)  for  some  goods 
or  other,  whether  it  be  for  consumption  goods  or  for  those 
devoted  to  production. 

Note  3.  Temporary  hoarding  may  diminish  the  demand  for 
labor.  It  will  not  cause  an  increased  demand  for  gold  and  will 
diminish  the  demand  for  other  things. 

Corollary  3.  Governmental  extravagance  does  not  increase- 
employment. 

The  money  taken  from  taxpayers  would  have  been  used  to  buy 
goods  and,  so,  would  have  made  employment,  had  it  been  left 
with  the  taxpayers. 

Note.  1.  Of  course,  laborers,  as  consumers,  may  receive  ad- 
vantages from  governmental  expenditures  just  as  other  citizens 
do. 

Note  2.  Governmental  extravagance  may  temporarily  increase 
employment  in  a  period  of  industrial  stagnation.  Here  there  is 
more  or  less  temporary  hoarding.  See  Note  3  above. 

Corollary  4.  Producing  for  oneself,  when  it  is  done  without 
decreasing  one's  output  for  the  market,  does  not  diminish  em- 
ployment. 

For  example,  a  person  who  produces  through  his  property  or 
his  efforts  or  both,  say,  $1,000  worth  of  products  each  year 
does  not  diminish  employment  by  putting  in  some  spare  time 

356 


CHAPTER  XIII.     SYSTEM  OF  DISTRIBUTION 

building    himself    a    boat, — it    being    assumed    that    his    outside 
production   is  not  changed. 

Corollary  5.  Broadly  speaking,  an  increase  in  the  supply  of 
labor  services  creates  opportunities  for  employment  as  well  as 
absorbing  them,  though  not  usually  in  quite  the  same  proportion. 

Caution.  This  does  not  mean  that  the  process  in  question 
will  have  no  adverse  effect.  Without  doubt  it  will  tend  to  cause 
some  decline  in  the  rate  of  wages,  under  the  working  of  the  prin- 
ciple of  diminishing  productivity.  But  this  result  is  not  to  be 
confused  with  the  question  of  employment.  Besides,  in  not  a 
few  cases  which  receive  considerable  attention,  the  influence  on 
wages  would  be  negligible. 

Argument.  This  proposition  is  not  so  evident  as  the  preced- 
ing; nor  can  it  be  accepted  without  larger  qualifications  and 
limitations.  But  it  is  still  substantially  true.  If  the  whole 
producing  group  creates  a  demand  for  labor  by  producing,  it 
follows  that  the  labor  part  of  the  producing  group  creates  a  de- 
mand for  labor  by  its  producing. 

Doubtless  it  must  be  admitted  that  not  all  the  demand  created 
by  labor's  production  will  eventuate  in  a  demand  for  other  labor; 
since  labor's  demand  for  goods  will  be  a  demand  for  all  the 
factors  necessary  to  produce  those  goods,  viz.,  land  services 
and  capital  services,  as  well  as  labor  services.  But  with  the 
great  majority  of  commodities,  the  contribution  of  labor,  direct 
or  indirect  is  by  all  odds  the  most  important  element ;  so  that 
a  demand  for  one  dollar's  worth  of  product  is  a  demand  for 
almost  that  much  labor,  counting,  of  course,  all  the  labor  which 
from  first  to  last  contributes  to  the  result.* 

2.  Employment  as  Dependent  on  the  Supply  of  Land  and 
Capital. 

In  carrying  forward  the  argument  of  the  preceding  discussion, 
it  was  assumed  that,  in  demanding  goods,  the  public  create  an 
equal  demand  for  labor,  and,  so,  create  an  equal  amount  of  em- 
ployment. But  we  hardly  need  say  that  this  presents  only  a 
partial  view  of  the  matter,  since  production  requires  other 
factors  besides  labor,  viz.,  land  and  capital.  A  demand  for 
goods  can  not  constitute  a  demand  for  the  labor  needed  to  pro- 
duce those  goods,  unless  there  are  land  and  capital  available  to 
complete  the  combination. f 

*I  am  not  at  all  sure  that  this  is  not  overstated.      But   I   think  it   is  no*. 

•{•  It  is,  of  course,  equally  true  that  a  demand  for  goods  does  not  con- 
stitute a  demand  for  the  land  necessary  to  produce  those  goods,  unless 
there  are  available  labor  and  capital  to  complete  the  combination.  So  a 
similar  affirmation  may  be  made  with  respect  to  capital.  In  short,  in  a 
sense  each  kind  of  prodrctive  goods  constitutes  a  demand  for  the  others. 
Tetter,  p.  218.) 

357 


PRINCIPLES  OF  ECONOMICS 

The  preceding  comments  have  brought  out  the  point  that 
opportunities  for  employment  are  dependent  on  land  and  capital 
as  being  co-ordinate  requisites  of  production,  the  presence  of 
which  is,  therefore,  necessary  if  there  is  to  be  a  demand  for 
labor.  There  is  another  reason  for  affirming  the  special  depend- 
ence of  labor  for  employment  on  capital.  Besides  supplying  the 
produced  materials  and  instruments  of  production,  capital  com- 
monly plays  to  a  greater  or  less  degree  another  role,  viz., 
advancing  the  wages  of  current  labor.  Doubtless  it  is  true 
that  in  some  cases  wages  are  not  advanced  at  all.  But  in  the 
majority  of  cases,  they  are  advanced  in  the  sense  that  a  large 
part  of  the  wages  paid  by  the  entrepreneurs  during  any  particu- 
lar week  or  month  are  paid  for  labor  which  is  devoted  to  produc- 
ing incomplete  goods, — goods  which  will  give  money  returns 
only  at  a  later  period.-  Because  of  this  fact  production  involves 
a  waiting  additional  to  that  involved  in  supplying  the  materials 
and  instruments  necessary.  In  short  production  requires  some- 
where in  the  community  a  fund  of  circulating  capital,  neces- 
sary to  supply  the  current  wants  of  producers.  As  a  very  large 
part  of  its  duty  will  be  to  make  advances  to  laborers,  it  may 
well  be  called  the  wage  fund. 

Note.  Without  much  question  the  classical  economists  for  L, 
time  pushed  too  far  the  doctrine  that  employment  and  wages 
are  dependent  on  capital,  developing  a  special  theory  of  wages, 
known  as  the  wage-fund  theory.  According  to  this  doctrine 
in  its  cruder  form,  there  is  at  any  moment  a  fairly  determinate 
sum  of  capital  devoted  to  the  purchase  of  labor  services,  so  that, 
unless  the  number  of  workmen  changes,  no  change  in  the  average 
of  wages  can  be  made, — an  increase- to  one  class  being  offset 
by  a  corresponding  decrease  to  some  other  In  practical  appli- 
cation, this  theory  was  made  to  prove  the  futility  of  strikes  and 
most  other  methods  of  raising  wages.  So  stated  and  so  used, 
the  doctrine  probably  did  not  deserve  much  consideration.  Still 
it  is  a  mistake  to  deny  the  fundamental  truth  involved  in  the 
doctrine.  Employment  is  more  or  less  dependent  on  a  special 
section  of  capital,  reasonably  enough  called  the  wage-fund.  Other 
things  being  equal,  workmen  will  fare  better  in  the  community 
which  has  the  ampler  stock  of  circulating  capital  available  for 
the  advancing  of  wages. 

As  a  rough  summary  of  the  preceding  discussion,  we  may 
lay  down  the  following: 

Principle.  Broadly  speaking,  opportunities  for  employment, 
anyhow  satisfactory  opportunities,  vary  with  the  abundance  of 
natural  resources  and  capital. 

358 


CHAPTER  XIII.     SYSTEM  OF  DISTRIBUTION 

3.     The  Limits  of  Possible  Employment. 

In  the  preceding  discussion  we  brought  out  the  reciprocal 
dependence  of  land,  capital,  and  labor  for  'opportunity.  Rigidly 
interpreted,  this  doctrine  would  suggest  that  there  is  a  certain 
definite  limit  to  the  opportunities  of  each  of  these  factors, — 
or.  for  our  special  purpose,  to  those  going  to  labor,  i.e.,  to  em- 
ployment. Given  a  certain  outfit  of  natural  resources  and  capital, 
there  will  be  opportunity  to  utilize  a  certain  amount  of  labor  and 
no  more.  Such  an  interpretation  would  nicely  support  the 
popular  notion  that  there  are  just  so  many  jobs,  no  more  and 
no  less,  so  that  giving  one  of  them  to  one  person  necessarily 
takes  one  from  some  body  else  and  vice  versa.  To  the  trained 
economist,  this  way  of  looking  at  the  matter  seems  quite  un- 
warranted. But  possibly  our  present  discussion  may  serve  to 
give  it  some  color  of  sense.  Does  not  the  affirmation  that  land 
and  capital,  as  well  as  labor,  are  essential  to  production  support 
the  contention  that  labor  opportunities  are  strictly  limited?  In 
answering  this,  we  have  to  remind  ourselves  that  all  industry 
is,  during  some  period  anyhow,  in  the  condition  of  Returns 
Increasable  at  Diminishing  Rate.  That  is,  even  if  the  available 
quantities  of  land  and  capital  are  constant,  yet  increasing  the 
amount  of  labor  will  increase  the  total  return  to  the  combination 
though  not  proportionately.  Since  the  increase  in  return  is  the 
contributior  in  the  product  which  will  be  credited  to  the  addi- 
tional labor,  and  as  such  contribution  will  determine  the  price 
of  labor,  it  follows  that  the  new  conditions  will  lower  wages, 
still  this  win  not  alter  the  fact  that  the  new  labor  has  found 
employmem.  Accordingly,  as  a  summary  of  the  situation,  we 
seem  called  on  to  say  that,  under  ordinary  conditions  no  one 
need  lack  employment  if  he  is  content  to  accept  that  wage 
which  expresses  the  new  marginal  productivity  of  labor. 

The  point  made  in  the  preceding  paragraph — that  opportuni- 
ties for  employment  can  be  indefinitely  increased — was  perhaps 
sufficiently  qualified  to  make  it  substantially  true.  Still  the 
qualification  needs  development.  As  a  basis  for  the  argument, 
it  was  said  that,  during  some  period  anyhow,  industry  is  in  th? 
condition  of  returns  incrcasable  at  diminishing  rate.  Now,  it 
is  quite  as  certainly  possible,  that  industry  should  reach  a  stage 
where  its  returns  are  substantially  fixed,  where  they  hav<». 
reached  their  maximum: — even  if  the  efforts  of  another  laborer 
could  increase  the  output  somewhat,  still  the  additional  amount 

359 


PRINCIPLES  OF  ECONOMICS 

would  be  so  small  that  even  with  the  extremes!  conceivable 
economy  it  would  not  furnish  subsistence.  That  is,  employment 
is  so  far  dependent  on  land  and  capital,  and  the  possibilities  of 
industry  are  so  limited  that  a  time  is  always  liable  to  come  when 
opportunities  for  employment  can  not  experience  any  measurable 
increase, — no  more  laborers  can  be  utilized. 

We  have  just  seen  that  an  absolute  limit  to  employment  may 
be  reached  by  adding  labor  till  the  comomation  is  brought  to 
the  point  of  substantially  maximum  returns.  Doubtless  in  actual 
life  the  practical,  effective  limit  is  reached  considerably  earlier 
than  this.  The  decline  in  the  marginal  productivity  of  labor  does 
not  go  on  till  men  could  live  on  no  less.  Rather  it  stops  where 
they  will  live  on  no  less.  In  earlier  times  conquering  migration 
cut  the  Gordian  knot.  In  our  day  peaceful  emigration  commonly 
proves  sufficient,  though  occasionally  force  in  the  shape  of 
colonial  wars  comes  to  the  front.* 

4.     Employment  as  Affected  by  the  Rivalry  of  Capital. 

Roundabout  methods  are  generally  labor-saving  methods, 
hence  methods  which  in  themselves  decrease  !~he  need  for  labor 
as  compared  with  the  need  for  capital  Capital  therefore  appears 
as  in  some  sense  the  rival  or  competitor  of  labor.  This  fact 
has  naturally  given  rise  to  much  controversy  as  to  whether  the 
introduction  of  approved  methods  does  not  diminish  the  total 
demand  for  labor.  (1)  All  are  agreed  that  immediately  certain 
classes  of  laborers  suffer  by  being  thrown  out  of  employment 
and  compelled  to  make  new  adjustments.  (2)  Experience  com- 
monly shows  that,  in  any  given  industry  taken  as  a  whole,  there 
is  little,  if  any,  decrease  in  employment;  because  the  lowered 
price  due  to  lowered  cost  so  stimulates  demand  thai  the  old 
workers  are  needed  to  meet  that  demand  even  under  the  new 
and  more  efficient  methods.  (3)  The  lowered  price  due  to 
lowered  cost,  if  it  does  not  create  new  demand,  anyhow  releases 
buying  power  saved  because  of  the  lower  price,  which  will  be 
spent  on  new  products,  save  on  the  almost  inconceivable  hypoth- 
esis that  goods  have  become  so  abundant  and  their  marginal 
utility  so  low  that  people  no  longer  want  more  things.  But 
supplying  these  new  products  will  furnish  employment  oppor- 
tunities for  the  labor  displaced  in  the  old  industries. 


*Further,  in  our  day  relief  has  repeatedly  come  from  great  improvem  Tits 
in  method  which  have  pushed  far  into  the  distance  the;  point  of  maximum 
returns. 

360 


CHAPTER  XIII.     SYSTEM  OF  DISTRIBUTION 

Note.  These  last  considerations  would  not  show  that  the  in- 
troduction of  improvements  has  no  tendency  to  lower  wages  by 
making  labor  relatively  more  abundant  and  so  lowering  its 
marginal  utility.  We  are  here  concerned  only  with  opportunities 
for  employment  at  some  wage  or  other. 

5.     Employment  and  Foreign  Trade. 

One  of  the  most  obstinate  of  popular  fallacies  is  the  notion 
that  the  employment  opportunities  of  the  people  of  a  particula" 
community  are  diminished  by  carrying  on  trade  with  other  com- 
munities. Buying  outside  takes  away  jobs  from  one's  own 
people.  Against  this  notion  economists  have  always  protested. 

Principle.  Broadly  speaking,  changes  in  the  extent  to  which 
goods  are  bought  abroad  have  no  effect  on  the  amount  of  em- 
ployment. 

Caution.  Remember  that  in  this,  as  in  any  principle  ot 
science,  all  conditions  other  than  the  one  under  consideration 
are  assumed  to  be  unchanged.  For  example,  we  must  not  sup- 
pose that,  when  we  stop  buying  certain  things  abroad,  there  is 
an  inflow  of  capital  from  abroad.  Such  a  procedure  would  be 
introducing  a  change  in  conditions  other  than  a  mere  decline  of 
foreign  buying. 

Argument.  The  principle  laid  down  is  quite  obviously  a 
mere  corollary  from  the  Principle  of  Reciprocity  discussed  in 
Chapter  VII.  Foreign  trade  is  necessarily  reciprocal.  If  we 
are  buying  abroad,  we  must  be  selling  abroad, — must  be  deliver- 
ing the  foreigner  some  form  of  wealth,  anyhow  money.  But,  in 
producing  the  commodity  or  commodities  with  which  we  pay 
the  foreigner  for  our  purchases,  we  obviously  create  opportuni- 
ties for  employment  just  as  truly  as  we  should  by  producing 
the  imported  goods  at  home.  There  are  some  valid,  if  not 
weighty,  arguments  for  artificially  developing  certain  industries 
within  our  own  borders ;  but  this  "more  employment"  argument 
is  not  one  of  them. 

ILLUSTRATIVE  PROBLEMS. 

1.     From  Marryatt's  Midshipman  Easy : 

"Yes,  my  dear,  this  is  all  very  well  in  the  abstract,  but  hov* 
does  it  work?" 

"It  works  well.  The  luxury,  the  pampered  state,  the  idleness, 
— if  you  please,  the  wickedness  of  the  rich,  all  contribute  to  the 
support,  the  comfort,  and  the  employment  of  the  poor.  You 
may  behold  extravagance, — it  is  a  vice ;  but  that  very  extrava- 
gance circulates  money,  and  the  vice  of  one  contributes  to  the 
happiness  of  many."  Criticise. 

361 


PRINCIPLES  OF  ECONOMICS 

2.  "If  there  were  two   communities   on  the   same   industrial 
level,  each  with  an  aggregate  income  of  $10,000,000,000,  but  one 
of  these  distributed  this  income  so  that  the  wage  earners  took 
only  $3,000,000,000,   while   in  the  other  they  took  $5,000,000,000, 
surely  no  one  will  contend  that  the  volume  of  general  demand 
would  not  be  larger  in  the  latter."    Criticise. 

3.  Most   economists   believe   in   what  we  called   Say's   Law ; 
yet   most  of  them  also   favor   "making  work"   for  the  laboring 
classes  during  'an  industrial  depression,  i.  e.,  spending  money  for 
enterprises    which    would    not    for   their    own    sakes    have    been 
undertaken  at  this  time. 

(a)  Show   that   a    resort    to   this    expedient   seems    at   first 
sight  inconsistent  with  Say's  Law. 

(b)  Defend  a  resort  to  this  expedient  in  exceptional  cases. 

4.  "It  is  a  pretty  well  established  principle  that  the  extent 
of  the  demand  for  commodities  determines  business  prosperity. 
It  is  equally  clear  that  this  demand  is  governed  by  the  consump- 
tion   of   wealth    by    the    masses,    and    that    this    consumption    is 
determined  by  the  general  standard  of  living  in  the  community. 
Therefore    whatever   tends    to    develop    that   standard    of   living 
tends  to  promote  the  sale  of  commodities  and  thus  to  increase 
production.     Therefore  it  is  necessary  to  raise  the  standard  of 
wages  to  increase  production."     (R.  B.  Cunninghame  Graham.) 
Criticise  carefully. 

5.  A  millionaire  of  Los  Angeles  recently  donated  $300,000  to 
maintain  a  certain  propaganda.     The   Detroit   News   in  an  edi- 
torial comments  on  the  fact  as  follows:     "There  is  little  excuse 
for  appropriating  money  with   which  to  put  human   intelligence 
and   the    freedom    of   the   will    in   bondage.      However,    $300,000 
will  furnish  employment  to  a  certain  number  of  human  beings 
anyway.    The  money  will  flow  out  through  the  channels  of  trade 
and  be  very  helpful  to  the  commercial  world,  and  that  is  some- 
thing to  be  thankful  for." 

(a)  Will  this  expenditure  increase  the  total  amount  of  em- 
ployment?    Explain. 

(b)  Is  it  probable  that  the  channels  of  trade  will  have  any 
more  money  flowing  in  them?    Explain. 

6.  "It  seems   certain  that,    for  the  existing  population  any- 
how, the  final  effect  of  all  successful  efforts  to  establish  a  wage 
minimum,  whether  by  public  or  private  action,  must  be  to  increase 
the  number  of  the  permanently  unemployed." 

Argue  for  the  truth  of  this  statement. 

7.  "Admitting  the  truth  of   the   statement  in   Problem  6.   T 
still  believe  that  wages  will  in  the  long  run  be  raised  as  a  result 
of  the  various  efforts  which  are  being  made  to  fix  a  minimum 
below  which  wages  are  not  to  be  allowed  to  fall." 

Argue  for  the  soundness  of  this  opinion. 

8.  "In  the  long  run  the  entrance  of  women  and  children  into 
the  field  of  labor  does  not  drive  out  an  equal  amount  of  male 

362 


CHAPTER  XIII.     SYSTEM  OF  DISTRIBUTION 

labor.  Their  products  add  as  much  to  the  demand  for  labor 
as  their  labor  adds  to  the  supply  of  labor.  Consequently  no  one 
should  object  to  the  employment  of  women  and  children." 

Is  this  argument  conclusive  against  laws  restricting  the  em- 
ployment in  question? 

Section  G.    Special  Consideration  of  Interest. 

As  the  student  is  doubtless  aware,  it  is  the  incomes  deriverf 
from  property,  rather  than  those  derived  from  labor,  which  have 
given  rise  to  serious  controversies,  whether  in  respect  to  their 
origin,  their  determination,  or  their  legitimacy.  These  incomes, 
we  remember,  are  rent,  interest,  and  profits.  Among  these,  rent 
presents  comparatively  few  difficulties  and  has  given  rise  to 
few  great  theoretic  differences ;  though,  even  in  this  case,  perfect 
unanimity  is  lacking.  But  interest  and  profits  always  have  been, 
and  still  are,  subjects  much  in  controversy.  Of  the  two,  interest 
presents  the  greatest  difficulties  and  will  be  treated  first. 

1.    The  Interest  Phenomenon. 

Our  first  task  must  be  to  develop  fairly  clear  and  definite 
ideas  of  what  the  interest  phenomenon  is.  The  most  familiar 
case-  is  that  of  the  ordinary  money  loan ;  i.  e.,  a  transaction  in 
which  the  lender  puts  at  the  complete  disposal  of  the  borrower 
a  sum  of  money,  which  money  or  an  equivalent  sum,  is  to  be 
returned  to  the  lender  after  a  stated  period, — and,  in  return  for 
the  advantages  which  are  supposed  to  accrue  to  the  borrower 
from  this  operation,  said  borrower  makes  to  the  lender  a  special 
payment  amounting  to  a  small  per  cent  of  the  sum  loaned  and 
proportioned  to  the  length  of  time  for  which  the  loan  is  to  run. 
Said  special  payment  is  of  course  the  interest  we  are  talking" 
about. 

The  type  of  interest  involved  in  the  case  given  above  is 
commonly  called  contractual,  or,  sometimes,  explicit  interest. 
It  is  open,  avowed  interest.  But  there  are  besides  many  cases 
in  which  interest  is  just  as  truly  present,  but  in  which  it  is  more 
or  less  concealed,  disguised, — implicit  interest.  Thus,  merchants 
frequently  charge  higher  prices  for  the  same  goods  to  credit 
customers  than  to  those  who  pay  cash.*  Here  the  difference 
in  price  may  be  characterized  as  amounting  to  interest, — as  being 
in  effect  interest.  The  merchant,  in  having  to  wait  for  his  pay, 


*It  is  assumed  that  this  addition  to   price  is  not  made  in   order  to   covei 
risk. 

363 


PRINCIPLES  OF  ECONOMICS 

in  effect  lends  to  the  buyer  a  sum  of  money  equal  to  the  value 
of  the  goods.  If  he  openly  charged  interest  on  the  account, 
we  should  have  a  case  of  explicit  interest.  But  he  considers 
it  better  policy  to  conceal  the  fact  and  so  merely  charges  a 
higher  price  for  the  goods. 

A  rather  more  significant  case  of  implicit  interest  is  to  be 
found  in  the  relation  between  the  prices  of  ordinary  producible 
goods  and  their  costs  in  other  goods,  current  labor,  and  risk- 
taking.  Each  unit  of  product  has  to  have  a  price  high  enough 
to  cover,  not  only  the  items  just  enumerated,  but  also  interest 
on  the  invested  capital,  i.  e.,  on  the  sum  of  money  which  the 
entrepreneur  could  get  from  the  sale  of  his  whole  outfit.  This 
must  be  so,  the  business  man  would  say,  because  otherwise  no 
one  would  devote  his  money  to  manufacturing  commodities ; 
instead  every  one  would  lend  it,  getting  contractual  or  explicit 
interest.  This  is  inadequate  if  it  is  meant  to  be  a  complete 
explanation  of  interest;  since  sums  of  money  are,  »o  to  speak, 
merely  formal  capital,  and  the  deeper  explanation  must  be  found 
in  the  relations  to  each  other  of  those  things  which  borrowed 
money  is  used  to  buy  rather  than  in  money  relations  as  such. 
But,  after  all,  treating  the  fact  that  money-loan  interest  exists 
as  a  reason  why  implicit  interest  must  exist  is  not  substantially 
wrong;  since  it  is  in  the  market  for  money-loans  that  the  various 
forces  which  are  causing  interest  to  exist  and  determining  its 
rate,  most  completely  manifest  themselves.  Accordingly,  the 
business  man's  method  of  arguing  at  this  point  supplies  a  clue 
which  will  tell  us  where  to  look  for  implicit  interest.  That  is, 
wherever  we  find  a  person  occupying  an  economic  relation  such 
that  because  of  that  relation  he  is  depriving  himself  of  an 
opportunity  to  make  money  loans  and  receive  interest  therefor, 
we  may  be  sure  that  we  have  a  case  of  implicit  interest.  Such  a 
situation  we  shall  always  have  when  the  person  in  question 
owns  property  which  gives  off  its  services  only  piecemeal,  which, 
therefore,  must  be  owned  during  some  measurable  period  of 
time.  In  short,  every  case  of  durable  goods  involves  the  interest 
phenomenon. 

ILLUSTRATIVE  PROBLEMS. 

1.  Show   just  how  the   interest  phenomenon   is   involved   in 
the    non-producible    income-bearers    discussed    in    Section    G,    3, 
Chapter  IX. 

2.  Do  the  same  for  producible  income-bearers,  say,  gasoline 

364 


CHAPTER  XIII.     SYSTEM  OF  DISTRIBUTION 

launches    rented   by   the   day   or   week   at   some    summer    resort. 
Compare  the  two  cases. 

3.  Try  to  make  an  argument  to  prove  that  even  in  the  case 
of  a  durable  good  which  is  not  an  income-bearer  in  the  ordinary 
sense,  being  devoted  to  yielding  its  owner  an  income  of  services 
used  directly  to  give  himself  satisfactions,  we  must  believe  that 
interest  is  in  a  very  real  sense  involved.  (Take  the  example 
of  a  $1,200  automobile  destined  for  the  buyer's  own  use, 
expected  to  last  only  four  years,  and  ask  yourself  how  much 
valuation  he  must  set  on  an  annual  use  of  the  machine  to  make 
his  purchase  reasonable.) 

2.     Essential  Nature  of  the  Interest  Phenomenon. 

The  surface  marks  of  the  interest  phenomenon  offer  no  great 
difficulty  and  have  probably  been  brought  out  with  sufficient 
distinctness  in  the  preceding  discussion.  When,  however,  we 
inquire  as  to  the  real  inner  nature  of  interest,  we  have  a  very 
different  story.  From  the  earliest  time  there  have  been  serious 
controversies  with  respect  to  the  rightfulness  of  interest-taking; 
and  these  controversies  have  continued  unsettled  down  to  our 
own  day.  Now,  this  perennial  character  of  the  controversy 
is  largely  due  to  the  difficulties  experienced  in  trying  to  ascertain 
the  real  nature  and  origin  of  interest. 

Of  the  various  attempts  to  characterize  with  precision  the 
real  nature  of  interest,  two  have  been  most  in  vogue  and  perhaps 
may  be  said  to  include  most  of  the  others :  the  use  theory  and 
the  exchange  theory.  The  former  way  of  conceiving  the  matter 
is  almost  universal  in  the  business  world  and  has  been  widely 
held  by  economists,  though  in  recent  years  it  has  largely  given 
place  to  the  exchange  theory.  According  to  the  use  doctrine, 
interest  is  a  payment  for  the  use  of  capital  conceived  as  a  sum 
of  money  or  money  value  embodied  in  any  capital  good.  If  a 
manufacturer  borrows  at  the  bank  on  his  ninety-day  note  $600 
to  buy  200  tons  of  coal  wherewith  to  run  his  engines,  he  obvi- 
ously gets  all  the  uses  of  the  coal  but  in  addition  he  may  be 
said  to  get  a  ninety-days  use  of  the  $600  embodied  in  the  coal. 
Similarly,  if  Mr.  Elder  buys  a  $1200  automobile  on  a  one-year 
note,  he  gets  all  the  services  which  any  cash  buyer  could  get 
out  of  the  machine  and  in  addition  is  thought  of  as  getting 
the  use  of  $1200  for  a  year's  time. 

In  explaining  the  nature  of  the  exchange  theory,  our  best 
procedure  perhaps  is  to  begin  by  pointing  out  the  fault  in  the 

365 


PRINCIPLES  OF  ECONOMICS 

iise  doctrine.  No  one  denies,  of  course,  that  the  borrower  or 
the  credit  buyer  gets  some  advantage,  service,  utility,  in  addition 
to  the  services  of  the  coal  or  the  automobile; — if  he  did  not, 
he  surely  would  not  pay  the  interest.  But  those  who  reject 
the  use  theory  affirm  that  that  theory  errs  in  its  method  of 
characterizing  or  classifying  said  advantage  or  service.  The 
advantage  of  the  man  who  buys  goods  with  borrowed  money 
or  on  credit  consists,  not  in  receiving  a  greater  sum  of  utilities 
than  the  men  who  buy  similar  goods  with  their  own  money  or 
for  cash,  but  in  that  he  pays  what  is  to  him  a  smaller  price. 
He  is  given  all  the  prerogatives  which  belong  to  an  owner  who 
has  purchased  the  goods,  although  he  has  not  made  the  comple- 
mentary sacrifice  involved  in  buying  them, — has  not  in  the 
deepest  sense  bought  them  at  all.  .  In  short  his  additional  advan- 
tage over  the  non-credit  buyer  consists  in  postponing  the  sacrifice 
necessary  to  becoming  the  rightful  owner  of  the  utilities  of  the 
goods. 

The  exchange  theory  as  to  the  nature  of  interest  is  now 
readily  comprehended.  According  to  that  theory,  interest  is  in 
rtaHty  a  bonus,  a  premium,  a  something  to  boot  which  the  man 
who  buys  goods  now  but  docs  not  himself  pay  for  them  till 
some  future  time,  gives  to  the  person  who  enables  him  to  effect 
this  transaction.  Or,  looking  at  the  matter  from  the  lender's 
end,  as  better  fits  some  cases,  interest  is  a  bonus  or  premium 
which  the  man  who  relinquishes  his  right  to  goods  now  but 
gets  his  pay  only  at  a  later  date,  receives  for  making  this 
exchange.  To  put  the  theory  in  more  conventional  form :  When- 
ever present  goods  are  exchanged  for  future  goods,  a  bonus  or 
premium  is  paid  by  the  party  who  brings  to  the  exchange  future 
goods,  to  the  party  who  brings  present  goods ;  and  this  bonus 
or  premium  constitutes  interest. 

Note.  While  I  am  disposed  to  agree  with  the  advocates  of 
the  exchange  theory,  I  find  it  difficult  to  avoid  altogether  such 
expressions  as  this:  "Interest  is  paid  for  the  use  of  capital,  or 
the  services  of  capital" ;  and  I  do  not  believe  that  this  usage 
is  productive  of  any  serious  harm. 

3.     Are  Capital-services  Productive? 

In  discussing  the  Productivity  Principle  in  the  earlier  part  of 
this  chapter,  it  was  assumed  that  that  principle  applies  to  the 
services  of  capital  as  well  as  to  those  of  land  and  labor.  But, 
obviously,  this  is  legitimate  only  on  condition  that  capital  ser- 

366 


CHAPTER  XIII.     SYSTEM  OF  DISTRIBUTION 

vices  are  productive  in  some  serious  meaning  of  the  term. 
But  this  is  an  assumption  which  would  seem  to  many  persons 
quite  unwarranted.  Indeed,  it  would  seem  that  any  one  who 
gives  his  adhesion  to  the  Exchange  theory  just  explained  is 
thereby  estopped  from  claiming  that  capital  is  productive.  Is  it 
not  in  the  very  essence  of  that  theory  to  deny  productivity 
in  that  it  declares  that  the  credit  buyer  does  not  get  any  more 
utilities  than  the  cash  buyer,  but  merely  postpones  payment  for 
those  be  does  get?  Now,  I  am  not  disposed  to  deny  that  there 
are  definitions  of  the  word  produce  eminently  convenient  if  not 
quite  indispensable,  which  are  too  narrow  to  include  the  offices 
of  capital.  I  might  even  be  willing  to  concede  that  the  definition 
suitable  for  the  majority  of  purposes  is  in  this  class.  -But  we 
must  still  insist  that,  in  a  deeper  and  very  important  sense, 
capital  is  truly  productive, — the  capitalist  is  a  producer.  Pro- 
duction, in  its  fullest  sense,  must  include  every  act  which  is 
consciously  performed  in  response  to  economic  motives  and 
which  results  in  some  economic  advantage,  i.  e.,  an  advantage 
for  'which  men  are  willing  to  pay  a  price.  Any  narrower 
definition  than  this  is  entirety  unsuited  for  dealing  with  the 
problems  of  distribution  whicn  inevitably  bring  to  the  front 
questions  of  right  and  wrong,  claims  or  rights  produced  by 
actions,  and  which,  in  doing  this,  compel  us  to  locate  responsi- 
bility,— to  determine  to  whom  and  to  what,  any  particular  advan- 
tage is  properly  to  be  credited.  Again,  this  definition  is  alone 
adequate  in  that  it  brings  out  the  only  result  which  can  properly 
claim  to  be  the  true  end  of  all  economic  production — i.  e., 
advantage.  Time  was  when  production  must  result  in  added  raw 
materials.  Later  thinkers  became  liberal  enough  to  be  satisfied 
if  it  only  manufactured  those  materials.  Still  later  the  mere 
transporting  of  things  was  recognized  as  productive.  And  so  on. 
Now,  all  this  shows  that  the  truly  correct  procedure  is  to 
admit  that  the  only  necessary  mark  of  production  as  respects 
the  result,  is  that  it  brings  into  existence  advantages.  Judged 
by  such  a  conception  of  production,  the  role  of  the  capitalist. is 
surely  a  productive  one. 

In  the  preceding  discussion  we  have  argued  for  the  produc- 
tivity of  capital  broadly,  in  a  general  way.  The  great  importance 
of  the  question  seems  to  demand  a  little  more  specific  considera- 
tion of  the  really  significant  case,  i.  e.,  the  case  of  capital  which 
is  being  employed  productively  in  the  popular  meaning  of  the 

367 


PRINCIPLES  OF  ECONOMICS 

term,  e.  g.,  the  raw  materials,  engines,  machinery,  etc.  of  a  chair 
factory.  Is  it  proper  to  impute  any  portion  of  the  product  of 
such  a  factory  to  the  capital  invested,  as  capital,  i.  e.,  as  some- 
thing different  from  the  labor  necessary  to  produce  that  capital? 
Thus,  to  use  a  highly  artificial  example,  let  us  suppose  that  a 
certain  chair  factory  turns  out  each  month  70,000  chairs,  of 
which  number  20,000  become  in  effect  the  wages  of  current 
labor,  40,000  become  in  effect  the  wages  of  past  labor  embodied 
in  the  materials,  engines,  machines,  etc.,  while  10,000  become 
the  return  to  the  cacitalist. — it  being  assumed  that  the  landlord 
and  the  entrepreneur  as  such  get  nothing ;  question :  Are  the 
10,000  chairs  which  go  to  the  capitalist  as  such  properly  credited 
to  said,  capitalist  as  in  some  sense  his  product,  or,  in  strict 
scientific  accuracy,  must  they  be  credited  to  the  past  labor  in- 
volved as  its  product,  even  though  for  some  other  good  reason 
they  ought  to  become  the  share  of  the  capitalist?  I  hardly  need 
say  that,  consistently  with  our  previous  contentions,  we  can  not 
avoid  answering  that  they  must  be  credited  to  the  capitalist  as 
his  product.  Our  reasons  for  this  conclusion  are  best  brought 
out  in  a  series  of  formal  propositions. 

(1)  Even  if  capitalistic  production,  as  contrasted  with  non- 
capitalistic,   must  be   conceived   as   involving   merely   a   different 
method    of    utilizing    labor,    yet    the    employment   of   this    mors 
efficient  method  involves  conscious  choice, — it  does  not  go  as  a 
matter  of  course. 

(2)  The  choice  of  the  capitalistic  method  involves  the   ful- 
filment   of   a   condition — having    power    to    wait — which    can    be 
fulfilled  by  laborers  only  to  a  very  small  degree. 

(3)  The    supplying   of    this    necessary    condition   can,   how- 
ever, be  undertaken  by  persons  other  than  laborers,  and  so  the 
supply  of  power  to  wait,  and  therefore  the  extent  to  which  the 
more   efficient   capitalistic   method  can   be   employed,   can   be   in- 
fluenced  by  persons   other  than   laborers.     In    consequence,   the 
power  to  enable  producers  to  employ  said  methods  becomes  an 
ordinary    economic    good,    a    good    distinguishable    from    other 
factors  and  having  a  price. 

(4)  The    volume   of  this   additional    factor    in   production — 
waiting   power — is   limited,   and   so    limited   that   in    many   case.r 
producers   are   obliged    to    forego    the    employment    of   methods 
which  would  be  more  efficient  than  those  they  do  employ. 

(5)  Under   these    conditions,    producers    are   'bound    to    feel 
that,  even  in  the  least  important  case  where  it  is  used,  the  power 
to   choose   the    more  capitalistic    method    is   really   important   to 
them,  and  feeling  this  they  must  credit  to  it  some  portion  of  the 
product;  since  otherwise  they  might  easily  make  the  mistake  oi 

368 


CHAPTER  XIII.     SYSTEM  OF  DISTRIBUTION 

using  it  for  some  less  important  purpose, — for  producing 
submarginal  product.  That  is,  capital  as  capital, — capital  as 
waiting  power  in  distinction  from  capital  as  the  result  of  labor, — > 
must  be  credited  with  a  part  of  the  joint  product, — is,  then,  truly 
productive. 

ILLUSTRATIVE  PROBLEMS. 

1.  "That  capital  is  productive  has  often  been  questioned,  but 
no  one  would  deny  that  tools  and  other  materials  of  production 
are  useful ;  yet  these  two  propositions  mean  exactly  the  same 
when  correctly  understood." 

Show  that  those  persons  who  object  to  calling  capital  pro- 
ductive would  hardly  be  satisfied  with  the  above  proof.  (For 
the  use  which  the  author  quoted  made  of  the  productivity  of 
capital,  his  conception  of  productivity  is  all  right  enough ;  but 
it  is  not  the  conception  of  those  whom  he  affects  to  answer.) 

2.  Suppose  that  a  fisherman  could  catch  21  fish  a  day  with- 
out the  aid  of  a  net  01  boat  or  any  other  form  of  capital;  that 
to  make  a.  net  would  cost  him  thirty  days'  labor;  and  that  it 
would  last  only  thirty  days. 

(a)  What   is    the   smallest   number    of   fish    which    the    net 
must    enable    him    to   catch    each    day    in    order    to    justify    our 
saying  in  this  case  that  capital  as  capital  is  productive? 

(b)  Supposing  that  the  fisherman   catches  with  the  aid  of 
the  r.et  200  fish  a  day,  what  is  the  maximum  productivity  which 
could  be  credited  to  the  capital  as  capital. 

(c)  Under   what  circumstances   would   that   maximum  tend 
to  be  so  credited  to  capital? 

(d)  Supposing  that  only  1000  fish  were  actually  credited  to 
the  net  as  its  product,  how  would  you  explain  the   fact? 

(e)  Can  you  imagine  a  condition  of  things  under  which  no 
part  of  the  catch  would  be  credited  to  the  net'' 

3.  In  order  that  we  should  impute  productivity  to  capital,  is 
it  necessary  that  some  part  of  the  capital  supplied  should  have 
a  cost  of  abstinence  or  waiting? 

4.  It  is  usual  to  say  that  even  goods  ready  for  consumption, 
e.g.,  a  loaf  of  bread,  are  capital  so  long  as  they  are  in  the  hands 
of  the  producers  or  dealers. 

(a)  Try  to  show  that  such  a  way  of  looking  at  the  matter 
is  reasonable. 

(b)  Is  there   any   interest  present  in   such   a   case? 

(c)  Can  such  capital  properly  be  described  as  productive? 

4.  Does  the  Return  to  Capital  Submit  Itself  to  the  Pro- 
ductivity or  Service-Value  Principle? 

Our  affirmative  answer  to  the  previous  question  almost  in- 
volves the  same  one  here.  Still  it  might  be  argued  that  the 
peculiar  character  of  the  element  under  consideration  renders 

SCO 


PRINCIPLES  OF  ECONOMICS 

less    likely    our    successful    isolation    of    its    share    in    the    joint 
product,  even  if  one  admits  that  it  has  such  a  share.     An  engine 
is  capital,  or  anyhow  capital  goods ;  but  we  do  not  mean  by  the 
contribution  of  the  engine  all  its  contribution.     The  larger  part 
of  that  contribution  is  to  be  credited  to  the  labor  spent  in  pro- 
ducing the   engine.     Here  we  are  concerned  only  with  the  part 
of   the  whole  contribution  imputable  to  the  waiting  power   em- 
bodied in   the   engine.     To   expect   entrepreneurs   to  isolate  this 
would  seem  to  be  attributing  to  them  quite  exceptional  powers 
of  analysis  as  well  as  exceptional  capacity  to  trace  the  working 
of  intermingled  forces.     But  all  this  is  a  bogey  whiti    need  not 
frighten  any  one.    (a)   As  already  fully  explained  in  Section  G, 
Chapter  IX,  the  process  whereby  each   factor   in   production   is 
assured    a    price    expressing    its    marginal    contribution    is    an 
automatic  process   involving  comparatively  little  insight  on   the 
part  of  entrepreneurs,     (b)   But,  in  reality,  the  case  of  waiting 
power  offers  in  actual  practice  no  greater  difficulties  than  other 
factors.    To  the  entrepreneur,  waiting  power  presents  itself  as  a 
thing  which   he  buys  in  isolation   on  the  open   market ;   i.e.,   as 
the  right  to  use  some  other  man's  money.    When  he  is  consider- 
ing whether  or  not  it  will  pay  him  to  make  his  methods  more 
capitalistic — to   use   a    larger   proportion    of    congealed    labor,    a 
smaller    one   of   current   labor — the    answer   turns    on    one    very 
simple  matter,  the  rate  of  interest.    It  is,  of  course,  true  that,  if 
an  entrepreneur  puts  $10,000  worth  of  labor  into  the  improving 
of  his  plant,  this  procedure  must  cost  him,  not  only  the  $500  in- 
terest on  the  money,  but  also  the  $10,000  expended  for  the  labor, 
and,  so,  surely  the  returns  from  the  business  must  be  adequate 
to  cover  the  $10,000  as  well  as  the  $500.     But,  then,  this  is  no 
concern  of  the  interest  problem.     That  problem  has  to  do  only 
with  the  choice   between   two   methods  of  utilizing  the   $10,000 
worth  of  labor;   the  direct  and  the   roundabout.     The   cost  of 
the  labor  is  in  either  case  $10,000;  but  the  cost  of  the  power  to 
choose  the  roundabout  instead  of  the  direct  method  is  only  $500. 
In    the    actual    world,    accordingly,     the    task    of    ascertaining 
whether   waiting   power   is    worth    to   the   entrepreneur    what   it 
costs    him    offers    no    greater    difficulties    than    the    same    task 
in   the    case   01    labor.      We   conclude,   then,    that   the   reasoning 
which  was  employed  by  Section  A,  Chapter  X,  to  show  that  the 
market  automatically  isolates  the  marginal  contribution  of  each 
factor  and  assures  to  that  factor  a  corresponding  price,  finds  no 

370 


CHAPTER  XIII.     SYSTEM  OF  DISTRIBUTION 

peculiar    difficulties    in    dealing    with    the    case    of    capital    and 
interest. 

5.  Does  the  Return  to  Capital  Submit  Itself  to  the  Disutility 
Principle? 

That  there  is  a  disutility  or  sacrifice  involved  in  supplying 
capital  has  already  been  argued  more  than  once,  and  would 
seem  to  need  little  more  comment.  It  may  be  that  we  shall 
have  to  relinquish  altogether  the  earlier  doctrine  that  in  absti- 
nence we  have  a"  cost  coordinate  with  labor,  and  accept  instead 
the  contention  of  Boehm  that  the  capitalist's  sacrifice  consists, 
not  in  an  increased  cost,  but  rather  in  a  diminished  reward  for 
incurring  the  original  cost.  But  even  so,  we  have  an  added 
sacrifice  the  making  of  which  is  necessary  if  we  would  pursue 
capitalistic  methods.  The  supplying  of  capital,  therefore,  in- 
volves a  disutility  or  sacrifice. 

The  question  still  remains,  however,  as  to  whether  there  is 
any  such  connection  between  the  disutility  cost  of  capital  and 
the  market  price  of  its  use — the  rate  of  interest — that  said  price 
must  express  the  marginal  disutility  involved  in  supplying  the 
capital.  Doubtless  we  must  admit  that  a  negative  answer  is 
possible.  The  volume  of  accumulation  is  unquestionably  influ- 
enced by  other  conditions  than  the  rate  of  interest.  For  ex- 
ample, some  persons  are  in  a  position  to  spare  from  the  present 
without  appreciable  sacrifice  while,  at  the  same  time,  they  are 
anxious  to  provide  a  fund  for  the  future.  Such  persons  would 
accumulate  capital  even  if  they  were  obliged  to  pay  for  the 
privilege  of  doing  so.  It  is,  therefore,  conceivable  that  the 
amount  of  capital  actually  supplied  to  the  market  is  not  in- 
fluenced in  any  substantial  degree  by  a  regard  to  the  interest 
paid.  If  not  strictly  a  fixed-output  good,  it  would  be  one,  the 
output  of  which  would  have  its  fluctuations  determined  only 
through  the  power  of  forces  other  than  cost.  The  price  of  its 
use,  therefore,  would  not  have  to  conform  in  any  degree  to  the 
sacrifice  involved. 

But,  while  such  a  state  of  things  as  that  just  described  is 
conceivable,  its  actual  existence  seems  in  the  highest  degree 
improbable.  There  is  one  type  of  accumulation,  certainly,  which 
<s  motived  by  considerations  of  direct  economic  gain.  I  mean 
the  getting  together  a  small  sum  to  make  a  start  in  business 
or  speculation.  Doubtless  we  are  not  here  dealing  with  pure  in- 

371 


PRINCIPLES  OF  ECONOMICS 

terest — the  profit  expected  is  the  more  important  item.  Still  the 
case  must  of  course  involve  the  interest  problem ;  since  the  entre- 
preneur who  puts  his  own  capital  into  the  business  can  not  help 
performing  the  waiting  function  of  the  capitalist  as  well  as  the 
<-esponsibility-taking  function.  Now,  it  can  hardly  be  doubted 
that  every  year  a  large  amount  of  capital  comes  into  existence 
in  this  way ;  and  it  is  hard  to  believe  that  it  plays  no  part  in 
determining  the  rate  of  interest.  But,  finally,  it  seems  impos- 
sible to  believe  that  the  accumulating  of  that  portion  of  capital 
which  is  devoted  to  earning  interest  only  is  not  materially  influ- 
enced by  the  immediate  reward  in  the  shape  of  interest.  Surely 
there  must  be  not  a.  few  people  in  such  a  position  that  they 
naturally  say:  The  rate  of  interest  has  fallen  so  low  that  it 
really  is  not  worth  my  while  to  say  any  more ;  I  would  better 
enjoy  the  present.  If  so,  their  decision  for  or  against  further 
saving  must  surely  change  the  volume  of  capital  sufficiently  to 
modify  its  price.  Putting  the  matter  in  a  still  different  way, 
can  it  be  seriously  doubted  that  a  fall  in  the  rate  of  interest  to 
zero  would  diminish  the  stream  of  new  capital,  or  that  a  rise 
to  ten  per  cent  would  increase  that  stream?  If  not,  then  we 
must  say  that  the  price  of  the  use  of  capital  must  tend  to  ex- 
press the  marginal  disutility  of  supplying  it. 

ILLUSTRATIVE  PROBLEMS. 

1.  "It  is  absurd  to  call  a  course  of  action  which  is  deliberately 
chosen  as  preferable  to  its  opposite,  a  sacrifice.  When  the- 
capitalist  gives  up  a  present  good  in  order  to  gain  a  future  one, 
by  that  very  action  he  shows  that  he  is  not  making  a  sacrifice, 
i.e.,  he  shows  that  he  prefers  the  future  good  to  the  present  one.'r 
Prove  by  similar  reasoning  that  labor  is  not  a  sacrifice  cost.- 
2.  "The  old-fashioned  notion  that  capital  is  uuilt  out  of  sav- 
ings has  little  or  no  application  under  our  regime  of  corporate 
organization.  What  happens  nowadays  is  that  the  corporation 
simply  puts  some  portion  of  its  huge  earnings  into  improvements 
such  as  buildings,  machinery,  side-tracks,  etc. ;  so  that  saving 
fs  no  longer  required." 

(a)  Show  that  the  modern  method  as  expressed  in  the  second 
sentence  involves  no  essential  change  in  procedure. 

(b)  Show  that  this  modern  procedure  may  involve,  -probably 
does  involve,  not  a  few  cases  of  really  onerous  saving. 

ft.     The  Rate  of  Interest  and  the  Quantity  of  Money. 
A  very  persistent  and  troublesome  popular  fallacy  makes  the 
rate   of    interest   to    vary    inversely    as    the   quantity    of   money. 

372 


CHAPTER  XIII.     SYSTEM  OF  DISTRIBUTION 

This  fallacy  seems  to  spring  from  a  confusing  of  money  and 
capital.  Such  a  confusing  is  not,  perhaps,  so  very  unnatural  in 
view  of  the  fact  that  the  immediate  form  in  which  the  use  of 
capital  is  marketed  is  a  fund  of  money  or  its  equivalent,  bank 
credit.  In  fact  so  fully  is  this  true  that,  in  the  long  run  and 
supposing  no  tinkering  with  the  money  stock,  we  may  quite 
safely  take  as  our  guide  to  the  interest  relations  prevailing 
among  the  real  capital  goods,  the  market  for  mere  money 
capital.  But  this  is  only  because  in  the  long  run  those  interest 
relations  prevailing  among  the  real  capital  goods  find  full  ex- 
pression in  the  market  for  money  capital.  It  is  surely  in  the 
demand  for  and  the  supply  of  engines,  machines,  lumber,  etc., 
rather  than  in  the  demand  for  and  the  supply  of  mere  money 
that  we  should  look  for  the  more  ultimate  causes  determinative 
of  interest. 

Principle.  In  the  long  run,  the  rate  of  interest  must  be  de- 
termined in  substantial  independence  of  the  quantity  of  money. 

Argument.  A.  In  General.  What  the  borrower  really 
wants  is  not  money  but  goods, — engines,  cars,  rails,  labor,  etc. 
It  is  surely  foolish  to  expect  that  putting  out  more  coin  or  more 
paper  money  will  make  the  real  things,  engines,  cars,  etc., 
cheaper  to  borrowers,  or,  vice  versa,  that  withdrawing  money 
will  make  those  things  dearer. 

B.  More  Specifically.  If  we  suppose  the  rate  of  interest  to 
be  lowered  at  first  by  the  increase  of  money,  the  natural  working 
of  things  will  soon  reverse  the  movement.  (1)  The  lower  rate 
will  lead  to  extensive  borrowing  and  buying  of  goods.  (2)  This 
will  raise  the  prices  of  goods ;  since  they  have  not  increased 
though  the  money  has.  (3)  This  will  compel  borrowers  to  bor- 
row more  money  in  order  to  get  the  same  amount  of  goods. 
(4)  This  will  raise  the  rate  of  interest  back  to  its  old  place.* 

But,  while  in  the  long  run  we  can  not  expect  to  influence 
materially  the  rate  of  interest  (discount)  by  altering  the  quan- 
tity of  money  in  circulation,  we  can  for  brief  periods  accomplish 
the  result  named.  In  fact  governments  and  powerful  banks 
at  times  consider  it  one  of  their  functions  to  manipulate  the 
money  stock  for  the  express  purpose  of  raising  or  lowering 

*In  fact,  it  is  generally  held  that,  when  the  stock  of  money  is  increasing, 
the  expected  fall  in  its  value — rise  in  prices — will  cause  lenders  to  hold  back 
for  a  higher  rate  of  interest  in  order  to  insure  themselves  against  loss  on 
the  principal.  Argued  fully  in  Fisher's  Appreciation  and  Interest. 

373 


PRINCIPLES  OF  ECONOMICS 

the  rate  of  discount.  Thus,  the  Bank  of  England  has  in  several 
instances  contracted  the  circulation  of  London  in  order  to  force 
on  the  market  a  higher  rate.  Now,  the  possibility  of  bringing 
about  such  results  in  the  way  indicated  rests  upon  the  following 

Principle.  For  short  periods  (a  few  weeks  or  months},  the 
rate  of  discount  (interest)  tends  to  equal  that  rate  which  ex- 
presses the  marginal  utility  of  the  stock  of  money  capital  without 
much  regard  to  the  marginal  utility  of  goods  capital  or  the  dis- 
utility of  saving. 

Argument  A.  The  short-time  rate  adjusts  itself  to  the 
marginal  utility  of  money  capital  without  much  regard  to  goods 
capital,  because  short-time  loans  largely  connect  themselves  with 
the  need  for  money,  not  to  invest  productively,  but  to  meet  money 
obligations.  Here  the  demand  is  emphatically  for  money  itself, 
not  something  which  money  will  buy. 

B.  The  short-time  rate  adjusts  itself  to  the  marginal  utility 
of  money  capital  with  little  regard  to  the  disutility  of  saving. 
This  is  simply  the  old  case  of  short-time  normals  being  deter- 
mined without  respect  to  cost  of  production.  During  a  series 
of  years,  the  price  of  wheat  tends  to  equal  its  marginal  cost 
of  production.  But,  between  two  harvests,  its  price  tends  to 
be  one  which  expresses  the  marginal  utility  of  the  existing 
stock. 

ILLUSTRATIVE  PROBLEMS. 

1.  The   law   of   1900   for   the  better   protection   of   the   gold 
standard   provided   among  other  things   that   under  certain   cir- 
cumstances   treasury   notes    (greenbacks)    which   have   been    re- 
deemed shall  not  be  paid  out  even  in   exchange  for  gold,  but 
shall  be  hoarded,  thus  contracting  the  total  currency.     This  was 
doubtless  intended  to  protect  the  Treasury  when   a  heavy  gold 
export  was   in   progress ;  and,   whether   intended  or  not,  it  wilJ 
doubtless  tend  to  check  such  a  gold  export.     Argue  for  the  cor 
rectness  of  the  statement  after  the  semi-colon. 

2.  At  present  the   Imperial   Bank   of  Germany  has   the  un- 
conditional  right  to  issue   only   450  millions  of  uncovered    (not 
backed  by  an  equal  amount  of  gold)  notes ;  but,  by  paying  a  tax 
of  5  per  cent  on  any  excess  over  said  amount,  it  may  expand 
the  issue  indefinitely.     It  is  believed  that  this  power  can  be  used, 
and  is  used,  to  keep  the  rate  of  discount  much  more  uniform 
than  it  would  naturally  De.     Show  that  we  can  reasonably  look 
for  such  a  result. 

7.     The  Rate  of  Interest  and  Risk. 

It  is  a   familiar  fact  that  at  any   one  time  the  current  rate 
374 


CHAPTER  XIII.     SYSTEM  OF  DISTRIBUTION    - 

of  interest  on  capital  used  for  the  same  general  purpose  differs 
greatly  in  different  places,  say  Ann  Arbor  and  Spokane,  and  that 
even  in  the  same  place  at  the  same  time  it  perhaps  differs 
widely  when  the  capital  involved  is  put  to  different  uses.  The 
chief  explanation  of  these  differences  is  doubtless  inequality 
in  the  matter  of  risk.  The  excess  over,  say,  four  per  cent  in  a 
given  time  and  place  may  be  conceived  as  an  insurance  premium, 
a  contribution  to  the  fund  necessary  to  cover  losses  from  bad 
debtors,  or  perhaps  as  a  payment  necessary  to  overcome  the 
natural  indisposition  of  the  lender  to  take  chances.  If  we 
understand  by  "gross  interest"  the  amount  actually  paid  and 
by  "pure  interest"  the  rate  paid  to  cover  the  simple  use  of  capital 
or  waiting  power,  we  may  lay  down  the  following  principle, 
which,  though  obvious  and  familiar,  is  of  great  importance  and, 
unfortunately,  is  often  overlooked. 

Principle.  The  amount  by  which  gross  interest  in  any  par- 
ticular case  exceeds  pure  interest  tends  to  vary  roughly  as  the 
risk  involved. 

ILLUSTRATIVE  PROBLEMS. 

1.  Show  that  usury  laws  would  tend  to   raise  the   rate  of 
interest. 

2.  Is  it  reasonable  to  accept  as  true  the  statements  of  a  bond 
agent  who  tells  you  that  the  bond  which   he  has   for  sale  is  a 
gilt-edged   one — i.e.,   that   is   absolutely   secure — although   it  pays 
7  per  cent  interest? 

3.  Give   examples   of  some   kinds   of   laws   which   you   think 
would  naturally  cause  the  rate  of  interest  to  rise  in  a  given  state 
or   country. 

4.  How  do  you  explain  the  fact  that  the  rate  of  interest  on 
ordinary  loans  will  often  be  6  or  7  per  cent  in  Detroit,  while 
at  the  same  time,  it  is  only  4  or  5  per  cent  in  New  York  City ; 
although  an  impartial  observer  would  hold  that  there  is   really 
no  greater  ibsolute  risk  in  the  one  case  than  in  the  other? 

Section  H.     Special  Consideration  of  Profits. 

1.     The  Nature  of   Profits. 

Profits,  as  the  term  is  frequently  used  by  the  general  public, 
include  the  zvhole  net  return  to  the  responsible  owner  of  a  busi- 
ness, i.e.,  the  whole  return  after  money  outlay  has  been  deducted 
from  money  receipts.  This  whole  return,  which  we  might  call 
Gross  Profits,  usually  includes  at  least  three  elements,  (1) 
wages  of  some  sort,  principally  for  management,  (2)  interest 

375 


PRINCIPLES  OF  ECONOMICS 

on  capital  invested,  and  (3)  a  remuneration  for  taking  the 
responsibility  of  production,  and  making  certain  final  decisions 
which  necessarily  fall  to  the  owner.  The  first  element  has  come 
to  be  eliminated  from  profits  even  in  the  popular  sense  of  the 
term  because  of  the  great  extension  of  the  corporate  form  of 
business  in  which  the  work  of  management  is  turned  over  to 
hired  officials.  The  second  element,  interest,  is  still  commonly 
included.  That  is,  stockholders  in  a  concern  paying  seven  per 
cent  dividends  would  commonly  think  of  the  business  as  yielding 
seven  per  cent  profit,  rather  than  four  per  cent  interest  plus 
three  per  cent  profit.  In  this  sense,  profit  is  contrasted  with 
interest  in  being  the  return  to  the  capitalist  who  bears  the  whole 
burden  of  ownership,  waiting  plus  responsibility-taking;  while 
interest  is  the  return  to  the  capitalist  who  assumes  only  one 
part  of  the  burden,  waiting.  In  economics,  however,  we  often 
find  it  convenient  to  limit  profits  to  the  third  element,  the  taking 
of  responsibility  and  making  final  decisions.  From  this  point 
of  view,  profits  in  the  case  above  would  be  only  three  per 
cent,  i.e.,  the  difference  between  what  the  capital  would  have 
received  if  lent  to  the  company  and  what  it  actually  did  receive 
as  invested  in  the  business.  Profit,  in  this  sense,  we  will  call 
Pure  Profits  or  Profits  Proper. 

(1)  Pure  Profits  involve  an  infinitestimal  element  of  wages, 
in  that  the  owner  must  make  certain  final  decisions.  But  in 
practice  this  tends  to  become  negligible.  (2)  Pure  profits,  as 
the  return  for  responsibility-taking,  involves  something  more 
than  a  remuneration  for  assuming  economic  risk;  for  assuming 
economic  risk  is  not  the  only  disutility  or  sacrifice  connected 
with  the  taking  of  responsibility.  But  no  doubt  risk-bearing 
is  the  chief  element  in  the  case. 

That  risk  for  the  bearing  of  which  profits  are  paid  must 
not  be  confused  with  the  regularly  recurring — calculable — losses 
of  a  business.  Such  losses  simply  increase  the  outlay  for  labo\ 
and  capital  goods.  The  remuneration  received  by  the  entre 
preneur  because  of  such  losses  would  never  be  thought  of  as 
profits,  but  only  as  replacing  of  costs.  The  risk  for  which  profits 
are  paid  is  the  risk  of  losses  which  cannot  be  recouped  in  the 
experience  of  the  individual  entrepreneur, — risks  of  total  failure. 
or  some  loss  almost  as  great.  Compare  tht  breakage  of  bottles 
in  the  brewery  business  with  the  chance  that  temperance  legis- 
lation will  destroy  the  business.  The  former  is  covered  by 

376 


CHAPTER    XIII.     SYSTEM    OF    DISTRIBUTION. 

greater  outlay.  The  latter  is  a  not-to-be-compensated  loss.  It 
cannot  be  met  by  any  fund,  unless  brewers  co-operate  to  insure 
one  another,  i.e.,  unless  competition  is  replaced  by  consolidation. 
Here  we  have  a  true  risk, — a  case  where  there  is  real  danger 
of  real  loss.  To  induce  men  to  assume  such  a  risk,  they  must 
be  paid  something,  not  of  course  enough  to  cover  the  loss  if 
the  risk  should  become  a  certainty,  but  enough  to  move  their 
wills,  to  induce  them  to  assume  the  risk.  It  is  thus  evident  that 
profits  must  not  be  conceived  as  a  contribution  to  an  insurance 
fund  from  which  losses  are  covered.  There  is  no  such  fund; 
the  losses  are  not  covered. 

Under  Socialism,  the  sort  of  risk  now  remunerated  by  profits 
would  in  the  main  be  covered  by  an  insurance  fund;  since  the 
state,  having  a  complete  monopoly  of  production,  would  pool 
m  its  own  hands  all  risks,  and,  as  well,  all  chances  of  occasional 
gain.  The  risk  cost  oi  production,  therefore,  would  oecomc 
simply  more  capital  and  labor  cost,  instead  of  being,  as  now, 
the  price  of  the  psychological  disutility  of  undertaking  risks. 
(Perhaps  the  latter  element  would  not  be  wholly  eliminated  in 
the  case  of  long  time  enterprises  undertaken  for  future  genera- 
tions.) It  is  probable  that  under  socialism  the  state  would 
charge  each  commodity  with  the  average  cost  of  the  whole  out- 
put of  that  commodity,  including  successful  and  unsuccessful 
branches  of  the  industry  involved.  Profits,  as  an  element  of  cost, 
vvould  not  therefore  be  eliminated  under  socialism,  but  would 
appear  in  another  guise. 

From  the  preceding  analysis  it  results  that,  under  the  present 
order,  profits  may  be  much  larger  or  much  smaller  than  the 
insurance  fund  necessary  to  cover  the  real  economic  risk.  It 
seems  probable  that,  where  risk  is  reduced  to  a  minimum,  profits 
are  larger  than  the  necessary  insurance  fund;  but,  where  risk 
is  very  great,  profits  are  much  smaller  than  the  necessary  insur' 
ance  fund. 

2.     The  Kinds  of  Profits. 

Profits,  we  hardly  need  say,  offer  much  greater  diversity 
than  any  other  of  the  regular  economic  incomes.  In  fact  one 
often  questions  the  propriety  of  treating  them  under  a  com- 
mon  head.  Still  they  all  have  the  common  mark  of  being  re- 
ceived by  the  person  or  persons  who  take  final  responsibility, 
and  they  all,  in  greater  or  less  degree,  connect  themselves  with 

377 


PRINCIPLES  OF  ECONOMICS 

the  most  conspicuous  element  in  responsibility-bearing,  i.e., 
risk-taking.  Their  differences,  however,  are  so  great  that  we 
are  almost  obliged  to  distinguish  them  in  any  full  treatment  of 
the  conditions  by  which  they  are  determined.  We  here  distin- 
guish four  chief  sorts. 

(a)  Ordinary  Profits.     By  these  we  mean  the  profits  realized 
in    well-established    lines    of    business    wherein    no    considerable 
amount   of    risk   is   involved.      Ordinary    profits,    again,    may   be 
subdivided  into  Necessary  and  Differential.     By  the  former  we 
mean  profits  which  must  be  paid  even  to  the  marginal  employer. 
By  differential  profits  we  mean  profits  received  by  entrepreneurs 
of  grades  superior  to  the  marginal  one,  in  excess  of  the  profits 
paid  to  the  latter. 

Notes.  (1)  A  number  of  prominent  economists  hold  tttat 
profits  tend  to  disappear  in  such  industries  as  those  here  con- 
sidered,— said  profits  being  eliminated  by  the  competition  of 
entrepreneurs.  We  will  give  some  reasons  for  the  contrary 
opinion  a  little  later. 

(2)  By  the  marginal  entrepreneur  we   mean,   not  the  least 
efficient  one  actually  producing,  but  rather  the  least  efficient  one 
of   those   actually  producing   who   under  normal  conditions  wilt 
continue  in  the   business  and  will  be  succeeded  by  others  who 
voluntarily  take  his  place.     The  purpose  of  this  statement  is  to 
exclude    from   consideration   a  type   of   entrepreneur   who   mu?t 
always  be  thought  of  as  an  anomaly  from  the  studv  of  whom 
no  valid  principle   for  normal  conditions  can  be  derived.     The 
type  in  question  is  the  man  who,  though  failing  to  make  profits, 
interest,  or  wages,   though   even   losing   little  by  little   his   very 
capital,  keeps  on  in  the  business  because  he  has  no  other  choice. 
The  facts  with  respect  to  such  an  entrepreneur  are  of  no  scien- 
tific  significance   in    studying   the   principles    of   price    or   those 
which  govern  distribution. 

(3)  It  is.  somewhat  doubtful  whether  we  ought  to  recognize 
the  kind  of  profits  above  designated  differential;  for  ihese,  being 
derived    from    the    superior    efficiency    of    one    entrepreneur    as 
compared  with  another,  seem  to  be  wages.     This  is  quite  correct 
as   respects    a   large   part   of   what   is   commonly   thought   of   as 
differential  profits.     Still,   it  is  probably  our  duty  to  retain   the 
category.     As  already  indicated  above  (page  376),  we  can  never 
completely  eliminate  from  the  function  of  the  entrepreneur  the 
element    of    management; — he    must    share    in    the    making    of 
certain  ultimate  decisions.     In  consequence,  there  will  tend  to  be 
a  residuum  of  differential  profits,  even  if  we  make  quite  universal 
the  corporation  practice  of  turning  over  the  function  of  manage- 
ment to  hired  servants. 

(b)  A  second  sort  of  profits  is  naturally  designated  Enter- 
prise Profits.     These  are  the  profits  reaped  by  the  initiators  of 

378 


CHAPTER   XIII.    SYSTEM    OF   DISTRIBUTION. 

industrial  enterprises.  They  almost  necessarily  contain  a  monop- 
olistic element.  In  the  case  of  patent  rights,  this  is  secured  to 
the  entrepreneur  by  the  action  of  the  public.  Oftener  the  tincture 
of  monopoly  comes  from  the  fact  that  the  development  of  com- 
petition takes  time,  and,  so,  the  pioneer  in  a  given  field  has  a 
quasi-monopoly  for  a  brief  period  after  success  becomes  as- 
sured. 

In  the  case  of  enterprise  profits,  it  is  more  difficult  than 
ordinarily  to  eliminate  the  element  of  wages.  As  a  usual  thinp. 
some  of  the  men  who  initiate  an  enterprise,  for  a  time  anyhow, 
perform  labor  services  in  connection  with  it,  e.g.,  promoting 
financing,  etc.,  and,  in  performing  these  functions,  often  do  not 
work  for  defined  salaries  or  commissions.  Even  if  a  defined 
commission  is  assured  them,  it  is  usually  in  the  form  of  shares 
in  the  business,  and,  so,  its  real  amount  is  conditioned  upon  the 
success  or  failure  of  the  enterprise  and,  hence,  is  conditioned 
more  or  less  fully  on  the  efficiency  or  inefficiency  of  the  receiver 
himself. 

(c)  Speculative  Profits  scarcely  need  any  definition  beyond 
their  name.     They  are  seen  when  men  consciously  speculate,  i.e.* 
consciously  deal  in  goods  for  the  sole  purpose  of   reaping  the 
gains  which  may  arise  from  changes  in  price. 

(d)  Accidental  Profits  arise  when  some  quite  unforeseen,  not- 
to-be-anticipated  condition  increases  the  income-producing  power 
of  a  given  property,  e.g..  the  decision  of  some  important  semi- 
public  institution  to  establish  its  quarters  in  a  different  part  of  a 
great  city.     This  naturally  increases  the  demand  for  neighboring 
sites  at  greatly  increased  rents. 

(e)  Monopoly  Profits  are  obviously  profits  received  by  the 
owners  cf  any  monopolistic  business. 

3.  Do  Profits  Submit  to  the  Productivity  or  Service-Value 
Principle  ? 

It  can  not  !*>e  denied  that,  of  all  the  regular  economic  shares, 
profits  are  decidedly  the  most  troublesome  when  we  try  to  place 
them  under  the  productivity  principle  when  rigidly  interpreted. 
Of  course,  there  is  no  difficulty  showing  that  the  receivers  of 
profits  as  a  class  perform  a.  service, — produce  something.  In 
some  sense,  anyhow,  profits  are  correlated  to  a  utility  produced. 
Further,  it  seems  almost  equally  certain  that  profits  are  in  some 

379 


PRINCIPLES  OF  ECONOMICS 

rough  way  proportioned  to  the  utility  rendered.  Thus,  all  must 
admit  that  those  persons  who  initiate  a  commercially  dubious, 
but  socially  important,  enterprise  perform  a  greater  service 
than  those  who  carry  on  the  same  in  later  years  when 
success  is  assured.  But,  granting  that  in  the  case  of  profits  there 
is  a  rough  correspondence  between  the  reward  and  the  service 
rendered,  it  does  not  seem  possible  to  affirm  even  the  degree  of 
correspondence  at  this  point  which  we  believe  exists  in  the  case 
of  wages  and  interest.  Accordingly,  some  specific  statements 
bearing  on  this  special  case  of  profits  seem  called  for. 

fa)  In  the  case  of  accidental  profits,  the  correspondence  be- 
tween service  rendered,  and  reward  received  is  obviously  very 
slight.  Profits  do  not  in  this  case  tend  to  express  the  marginal 
significance  of  the  receiver's  contribution. 

(b)  In  the  case  of  monopoly  profits,  there  ;s  doubtless  fairly 
close  correspondence  between  the  reward  and  the  marginal  sig- 
nificance of  the  supply  of  service  actually  rendered,  but  not 
between  the  reward  and  the  marginal  significance  of  the  supply 
of  service  which  would  naturally  be  rendered.  The  monopolist 
by  limiting  the  output  of  his  product  raises  its  marginal  utility, 
and  so  its  price,  above  the  marginal  utility  which  said  product 
would  naturally  have.  In  doing  this,  he  obviously  raises  his  own 
profits  above  the  amount  which  would  express  the  marginal 
utility  of  his  services,  were  no  limitation  set  on  their  output 

To  the  above  account  of  this  case  of  monopoly,  however,  one 
qualification  must  be  added.  The  monopoly  which  temporarily 
exists  may  have  been  anticipated,  and  hence  may  have  been  one 
of  the  conditions  which  induced  capitalists  to  undertake  the 
industry  in  question  when  they  would  not  otherwise  have  done 
so.  In  such  case,  we  may  say  the  monopolistic  output  is  the 
natural  one  and  so  the  case  comes  fully  under  the  service-value 
principle.  Cases  of  this  sort  are  supplied  by  the  legal  monopoly 
of  patents,  copyrights  and  franchises,  and  by  the  quasi-monopoly 
of  new  enterprises.  Here  the  extra  profit  does  not  correspond 
merely  to  the  higher  valuation  by  supra-marginal  buyers  ot  the 
service  rendered,  but  also  to  the  additional  service.  For,  surely, 
there  is  an  additional  service  when  men  undertake  to  try  out 
the  feasibility  of  a  new  enterprise, — giving  the  public  an  oppor- 
tunity to  find  out  the  real  utility  of  the  service  or  commodity 
said  enterprise  supplies. 

380 


CHAPTER    XIII.     SYSTEM    OF   DISTRIBUTION. 

In  spite  of  this  qualification  of  our  first  statements,  the  stu- 
dent must  not  suppose  that  economists  are  disposed  to  affirm  the 
service-value  principle  for  monopoly.  In  general,  the  presence 
of  monopoly  at  any  point  more  or  less  seriously  interferes  with 
the  realization  of  said  principle;  and,  assuming  for  the  moment 
that  said  principle  has  a  valid  claim  to  the  place  of  legitimate 
ruler  for  any  economic  order,  then  monopoly,  if  necessary  or 
permitted,  ought  to  be  regulated  or  controlled  in  the  public 
interest. 

(c)  The  case  of  Enterprise   Profits  has  been   mure  or   less 
anticipated  in  the  preceding  discussion  of  monopoly  profits.    Sucn 
profits  have   not  a   little   resemblance   to  prises.     Many   persons 
get  nothing;  a  few  get  large  rewards.     Under  these  conditions, 
we  can   scarcely  expect  profits  to   express   with  great  precision 
the  contribution  of  the  profit-receiver.     Yet  we  should  not,  on 
the    other    hand,    imagine    that    the    two    are    entirely    divorced. 
Opportunities    for    exploiting    novel    enterprises    are    constantly 
arising;  competition  for  such  opportunities  is  kept  fairly  brisk; 
the  goods  produced  must  command  prices  fairly  expressing  their 
marginal  utility;  the  marginal  contributions  of  the  other  factors 
are   at   the   same   time   being  more   or   less    fully   determined   in 
other  fields;  and  it  se^ms  not  unreasonable  to  assume  that  the 
residuum  of  product — which  constitutes  profits — is  properly  cred- 
ited to  the  entrepreneur  as  his  contribution. 

(d)  That   Ordinary    Profits    of   the   necessary    sort,    if  they 
exist   at   all,   tend   to   express  the   marginal   contribution    of   the 
entrepreneurs  does  not  seem  to  need  additional  discussion     Here 
the  elements  of  change  and  uncertainty  are  reduced  to  a  mini- 
mum ;  so  that  the  economic  processes  which  tend  automatically 
to  secure  each  factor  a  share  representing  its  contribution  to  the 
joint  product,  meet  little  hindrance  in  bringing  about  that  result. 

(e)  The  Differential  variety  of  Ordinary  Profits  will  surely 
express  with  considerable  precision  the  corresponding  contribu- 
tion of  the  entrepreneur,  since  by  its  very  nature  it  grows  out 
of  the  superior  productivity  of  that  entrepreneur.    This  is  seen 
by  analyzing  the  process  by  which  such  profit  arises.    The  price 
r*i  the   product   involved   is  fixed   at  cost    (including  necessary 
profits)   to  the  marginal  entrepreneurs.     A  higher  grade  entre- 
preneur can  now   get   differentia*!   profits  only  by  reducing  cost 
per  unit  and  so  getting  a  bigger  surplus  out  of  a  price  already 

381 


PRINCIPLES  OF  ECONOMICS 

fixed.  Now  this  condition  of  reducing  cost  he  fulfils  because 
for  some  reason  he  is  more  efficient,  creates  more  utility;  and 
the  size  of  the  surplus  thus  produced  will  depend  on  the  degree 
to  which  he  is  more  efficient,  i.  e.,  the  difference  between  him 
and  the  marginal  entrepreneur  in  respect  to  productivity. 

4.     Do  Profits  Submit  to  the  Disutility  Principle? 

It  is  obvious  that  a  negative  answer  is  necessary  in  the  case 
of  Accidental  and  Monopoly  profits.  The  same  answer  seems 
natural  in  the  case  of  Differential  profits,  though  this  is  not  so 
certain.  If  disutility  comes  into  any  case  of  value,  it  is  because 
the  failure  of  value  to  cover  that  disutility  causes  production  to 
fall  off,  and  so  compels  price  to  rise  till  said  disutility  is  cov- 
ered. If  the  usual  analysis  which  finds  price-determining  dis- 
utilities only  in  the  case  of  marginal  producers,  is  correct, 
differential  profits  would  be  a  sort  of  producers'  rent, — a  sur- 
plus usually  exceeding  the  corresponding  disutility.* 

Passing  to  the  case  of  Necessary  profits,  it  seems  certain 
that  these  must  express  with  fair  precision  the  marginal  disutil- 
ity involved  in  supplying  the  entrepreneur  service.  (1)  The 
demand  of  the  public  must  insure  for  the  product  involved  a 
price  high  enough  to  cover  the  disutility  undergone  by  the 
entrepreneur ;  since  otherwise  production  will  cease,  supply  will 
fall  off,  and  so  price  will  rise.  (2)  The  competition  of  entre- 
preneurs will  keep  price  from  going  higher  than  the  above  point ; 
since  their  numbers  can  be  recruited  at  all  times  from  those 
capitalists  who  merely  furnish  waiting  power,  i.e.,  lend  their 
capital  rather  than  invest  it. 

In  the  case  of  Enterprise  profits,  also,  correspondence  be- 
tween the  disutility  involved  and  its  reward  seem  necessary 
from  the  same  reasoning,  though  here  the  correspondence  is 
less  precise. 

Note.  It  does  not  seem  a  valid  objection  to  the  application 
of  the  disutility  principle  to  this  case  of  enterprise  profits  to 
say  that  there  is  too  much  chance  involved  in  these  cases  to 
insure  any  particular  result; — the  price  of  the  product  may  fail 
to  cover,  not  only  the  peculiar  disutility  of  the  entrepreneur, 
but  also  even  the  ordinary  outlay  for  material,  wages,  etc. ; 
while,  on  the  other  hand,  it  may  cover  all  that  outlay  and  give 
a  surplus  large  enough  to  insure  almost  any  conceivable  risk 

*It  is  possible  that,  in  respect  to  the  particular  disutility  under  con- 
sideration— responsibility-taking — the  more  efficient  entrepreneur  is  really 
the  marginal  one,  i.  e.,  the  one  to  whom  disutility  is  greatest.  In  that  case 
our  reasoning  could  not  stand. 

382 


CHAPTER    XIII.     SYSTEM    OF    DISTRIBUTION. 

several  times  over.  This  reasoning  quite  fails  to  recognize 
the  real  nature  of  the  responsibility-taking  disutility.  That 
disutility  is  not  expressed  by  the  term  "insure."  According  to 
that  theory  risk  comes  in,  not  as  a  chance  of  loss  to  be  covered 
by  insurance,  but  as  a  chance  of  loss  not  to  be  covered  at  all. 
The  taking  of  such  chances  involves  a  disutility.  To  induce  men 
to  incur  that  disutility,  a  prize,  or  bonus,  of  larger  or  smaller 
magnitude,  must  be  attainable  in  case  of  succesb.  The  size  of 
that  bonus  is  roughly  proportioned  to  the  risk,  though  the  unit 
of  variation  is  very  different  for  different  races;  and,  having 
been  fixed,  it  must  be  covered  in  the  price  of  the  product. 

5.     Do  Profits  tend  to  Disappear? 

A  rather  noteworthy  fact  in  recent  economic  discussion, 
particularly  in  this"  country,  is  the  manifestation  of  a  disposition 
to  hold  that  profits— pure  profits— tend  to  disappear.  The  argu- 
ment for  this  contention  moves  along  two  general  lines,  (a) 
It  is  affirmed  that  pure  profits,  assuming  them  to  be  paid  for 
risk-taking,  will  necessarily  disappear  with  the  elimination  of 
risk  from  industrial  affairs ;  and  such  elimination  is  steadily 
proceeding  through  the  increase  of  knowledge,  forethought,  in- 
vention, etc.  (b)  Secondly,  it  is  claimed  that  the  disutilities 
correlated  to  profits  are  disutilities  which  plenty  of  men.  particu- 
larly in  America,  are  quite  willing  to  assume  without  reference 
to  an  economic  reward.  In  support  of  this  contention  its  ad- 
vocates bring  forward  the  consideration  that  the  desire  for 
power,  the  craving  for  better  social  standing,  the  gambling  spirit 
which  eagerly  improves  the  opportunity  to  take  chances, — all 
these  unite  to  make  men  who  have  the  necessary  capital  and 
capacity  willing  to  undertake  the  responsibilities  of  production, 
even  though  they  expect  to  get  nothing  more  than  ordinary 
interest  on  their  capital  and  ordinary  wages  for  their  labor 
contribution. 

In  reply  to  the  first  of  the  above  arguments,  it  seems  sufficient 
to  declare  that  the  complete  disappearance  of  risk,  chance,  un- 
certainty from  industrial  affairs,  if  not  quite  -impossible,  i.s 
certainly  so  remote  that  it  can  not  properly  be  made  the  basis 
for  any  affirmations  with  respect  to  the  present  order.  Some 
centuries  hence  we  may  have  become  able  to  predict  the  weather 
for  a  year  in  advance  with  absolute  precision,  but  we  shall 
still  have  to  reckon  with  the  uncertainties  due  to  human  folly 
and  caprice. 

The  second  line  of  argument  is  less  easy  to  answer,  yet  will 

3S3 


PRINCIPLES  OF  ECONOMICS 

not,  I  think,  carry  conviction  to  most  persons.  The  first  two 
of  the  three  considerations  given  above  as  making  men  willing 
to  assume  the  responsibilities  of  production,  apply  to  hardly 
more  than  a  small  minority  of  the  entrepreneur  class  of  our 
day, — the  small  individual  or  partnership  entrepreneur  who  com- 
bines in  himself  the  functions  of  capitalist,  manager,  and  entre- 
preneur ;  for,  under  the  corporate  organization  of  industry, 
power  goes  to  salaried  officials,  and  the  social  position  of  bond- 
holders is  surely  as  good  as  that  of  stockholders,  assuming  their 
investments  to  be  equal.  But,  if  there  is  any  considerable  section 
of  the  entrepreneur  class  with  whom  these  non-economic  motives 
would  not  suffice, — who  would  insist  on  a  greater  economic  return 
for  taking  responsibility  than  for  simply  lending  their  capital — 
then,  profits  would  surely  have  to  be  paid. 

The  third  of  the  considerations  brought  forward  to  show 
that  men  will  undertake  the  responsibilities  of  the  entrepreneur's 
position  without  an  economic  reward, — viz.,  the  gambler's  desire 
to  take  risks — contains  the  old  confusion  of  ideas  which  has 
already  been  commented  on  more  than  once.  It  is  undoubtedly 
true  that  men  are  so  ready  to  take  risks,  when  a  possible  great 
prize  is  in  sight,  that  they  do  not  as  a  whole  class,  have  to  be 
remunerated  for  taking  that  risk.  In  other  words,  if  all  the  cop- 
per producers  of  the  world  spend  500  million  dollars  worth  of  labor 
and  capital  getting  out  the  product,  it  is  not  necessary  that  said 
product  should  be  worth  500  millions  plus  something  for  the 
risks  taken.  On  the  contrary,  that  product  will  probably  be 
worth  considerably  less  than  its  labor  and  capital  cost,  say  400 
millions.  But  all  this  is  beside  the  point.  The  real  issue  con- 
cerns, not  the  zvhole  class  of  entrepreneurs  interested,  but  only 
those  upon  whose  conduct  the  output  actually  supplied  depends, 
i.  e.,  the  successful  entrepreneurs.  Do  these  persons  have  to 
get  profits?  Surely  they  do,  else  there  would  not  be  this  gamb- 
ler's eagerness  to  assume  the  risks  of  the  business.  The  proper 
test  for  determining  whether  profits  of  the  sort  under  consider- 
ation, i.  e.,  a  remuneration  for  risk-taking,  really  exist,  is  this  : 
Does  society  have  to  pay  a  higher  price  for  a  particular  com- 
modity or  service  than  it  would  have  to  pay  if  risk  were 
eliminated?  Surely  there  can  be  but  one  answer  lo  that  question, 
viz.,  the  affirmative  one. 

384 


CHAPTER    XIII.     SYSTEM    OF    DISTRIBUTION. 

6.     Profits  as  Affected  by  Changes  in  the  Value  of  Money. 

In  an  earlier  discussion,  it  was  brought  out  that  the  value  of 
money  itself  may  change  and,  so,  general  changes  in  prices  may 
take  place  without  reference  to  the  conditions  ordinarily  govern- 
ing the  value  of  each  commodity.  Thus,  under  the  paper  money 
standard  of  civil  war  times,  there  was  a  general  rise  of  prices, 
i.  e.,  a  fall  in  money,  in  the  United  States.  So,  for  many  years 
following  1873  there  was  a  general,  thougn  gradual,  fall  in  prices, 
i.  e.,  a  rise  in  money,  affecting  most  or  all  of  the  Western 
nations.  Much  more  rapid  tips  and  downs  mark  the  periods 
immediately  preceding  and  following  commercial  crises  or  pan- 
ics. There  has  naturally  been  much  debate  as  to  how  far  such 
movements  influence  distribution,  ^it  this  point,  our  particular 
interest  in  these  changes  respects  their  influence  on  profits.  At 
first  thought,  perhaps,  the  student  is  inclined  to  say  that  of 
course  such  changes  influence  profits.  If  a  merchant  has  paid 
$100,000  for  a  stock  of  goods,  and,  because  of  a  universal  and 
simultaneous  fall  in  prices,  their  value  declines  to  $60,000,  how 
can  anyone  deny  that  the  merchant  is  losing  $40,000?  This 
sounds  plausible,  but  is  in  fact  a  very  evident  fallacy,  though 
a  common  one.  A  universal  and  simultaneous  fall  in  prices  of 
40  per  cent  raises  the  buying  power  of  $60,000  till  it  is  just  as 
great  as  was  that  of  $100,000.  Supposing  no  other  change  in 
conditions  to  occur,  the  merchant  in  question  neither  gains  nor 
loses  as  a  result  of  the  fall  in  prices.  But,  while  the  sort  of 
price  change  above  supposed,  i.  e.,  a  price  change  wherein  all 
prices,  including  those  of  labor,  move  up  or  down  simultaneously, 
has  of  itself  no  influence  on  profits,  the  general  price  changes 
of  actual  life  probably  do,  in  most  cases,  have  some  influence. 

(a)  In  so  far  as  entrepreneurs  are  debtors,  they  gain  by  a 
general  rise  in  prices  but  lose  by-  a  general   fall.    The  money 
significance  of  their  debts  does  not  change  with  prices,  but  that 
of  their  product  does. 

(b)  It  is  probable  that  general  price  movements  which  take 
place  with  considerable  rapidity  affect  profits  to  a  considerable 
degree.     This  is  because  such  movements  are  felt  by  commodi- 
ties more  promptly  than  by  labor  services  and  so  raise  or  lower 
returns  more  than  tney  raise  or  lower  costs. 

Section  I.     Special  Consideration  of  Rent. 
1.     The  General  Nature  of  Rent  has,  perhaps,  been  sufficiently 
emphasized  in  earlier  connections.     As  generally  understood  by 

385 


PRINCIPLES  OF  ECONOMICS 

economists,  it  is  the  ret.irn  which  accrues  to  the  owner  of  land 
conceived  as  independent  of  improvements,  though  it  is  admitted 
that,  in  some  cases,  separation  is  impossible, — the  improvements 
necessarily  sharing  the  economic  fate  of  the  land. 

2.  The  question  whether  land  submits  itself  to  the  Service- 
value  or  Productivity  principle  is  quickly  answered  in  the  affirm- 
ative Land,  being  a  factor  the  supplying  of  which  is  not, 
generally  speaking,  conditioned  on  man's  choice,  is  a  fixed- 
supply  good,  and  hence  the  process  whereby  each  factor  in 
joint  production  is  automatically  given  a  price  expressing  its 
marginal  significance,  would,  in  this  case,  work  itself  out  with 
exceptional  case.  The  result  is,  further,  more  fully  assured 
because  of  conditions  in  large  measure  peculiar  to  land,  (a) 
First,  land  naturally  grades  itself  into  classes  shading,  by  almost 
insensible  steps,  from  very  high  to  very  low  efficiency,  (b, 
Secondly,  competition  among  these  different  classes  is  assured, 
even  when  the  uses  to  which  they  are  put  are  very  diverse, 
from  the  fact  that,  while  not  all  the  members  of  one  class  can 
be  utilized  for  the  purposes  to  which  the  adjacent  classes  are 
devoted,  yet  enough  can  be  so  utilized  to  keep  these  effectively 
competing.  (Compare  the  case  of  two  large  reservoirs  with  a 
small  channel  connecting  them, — will  the  water  in  them  have 
one  level?  Read  Seager,  pp.  206-211.)  (c)  Up  to  the  present, 
anyhow,  there  are  not  a  few  inferior  grades  of  land  which  are 
not  yet  put  to  use,  because  human  need  has  not  yet  compelled 
their  utilization.  Under  these  conditions,  there  will  naturally 
be  some  lands  to  which,  though  they  are  put  to  use,  no  part 
of  the  product  is  credited ; — other  pieces  as  good  or  only  slightly 
inferior  being  unused  and  so  available  to  replace  these,  the  case 
is  lacking  in  that  scarcity  which  is  necessary  to  induce  us  to 
impute  any  portion  of  the  product  to  a  particular  factor.  (See 
note  on  page  473.  At  the  same  time,  no  rent  will  be  paid 
for  these  lands;  since  the  competition  of  the  lands  which  are 
not  used  at  all  would  hinder  the  owner  of  the  marginal  land  from 
getting  rent  for  his.  But  it  is  obvious  that,  if  a  certain  amount 
of  labor  and  capital  will  get,  say,  11  bushels  of  wheat  in  a  com- 
bination wherein  the  11  bushels  are  all  credited  to  the  labor 
and  capital  while  the  same  amount  of  labor  and  capital  can  get 
18  bushels  from  another  piece  of  land,  the  1  bushels  extra  will 
be  credited  to  the  land  as  its  product.  At  the  same  time,  it  is 

386 


CHAPTER  XIII.     SYSTEM  OF  DISTRIBUTION 

plain  that  the  competition  of  tenants  to  get  control  of  this  18- 
bushel  piece  will  put  the  7-bushel  difference  and  no  more  into 
the  hands  of  the  land-owner  as  rent.  Thus,  we  see  that  the 
portion  of  the  output  which  is  naturally  credited  to  the  land 
as  its  product  and  the  portion  which  inevitably  goes  to  the 
land-owner  as  rent  are  the  very  same  amount.  That  is,  rent 
necessarily  corresponds  with  great  precision  to  the  product 
which  the  rent-bearing  land  gives  off. 

3.  Does  Rent  submit  itself  to  the  Disutility  principle?  This 
question  presents  greater  difficulties  than  our  last  one.  If  it 
means :  Must  rent  be  what  it  is  because  the  marginal  disutility 
of  supplying  land  uses  is  what  it  is?,  our  answer  must  of 
course  be  in  the  negative.  As  already  explained,  the  disutilities 
involved  in  being  a  rent-receiver,  i.  e.,  a  land  owner,  are  deriva- 
tive, not  original.  They  are  what  they  are  because  the  income 
is  what  it  is,  not  the  reverse.  The  rent  of  land  does  not  have 
to  adjust  itself  to  the  original  disutility  of  supplying  land.  But, 
if  we  mean  by  our  original  question  merely  this :  Must  the 
disutilities  involved  in  being  a  rent-receiver,  i.  e.,  a  land  owner, 
and  the  rent  received  be  so  related  that  said  disutilities  are, 
broadly  speaking,  expressed  by  said  rent?,  the  answer  is  surely 
an  affirmative  and  one  not  greatly  qualified.  Under  normal  con- 
ditions the  market  price  of  any  piece  of  ground  will  approxi- 
mately equal  the  capitalization  of  its  net  income ;  in  consequence, 
persons  desiring  to  become  rent-receivers  will  be  obliged  to 
invest  their  full  capital  in  said  land  just  as  if  it  were  a  producible 
commodity;  and  so  gaining  the  position  of  a  rent-receiver  will 
normally  involve  assuming  the  ordinary  capitalistic  disutilities, 
abstinence,  waiting,  and  risk-taking.  Further,  this  process  of 
capitalizing  the  income  of  land  will  almost  certainly  work  itself 
out  in  such  a  way  that  the  income  pretty  closely  expresses  the 
disutilities  created.  This  is  of  course  inevitable  in  cases  where 
the  element  of  change  is  very  small.  That  is,  when  the  dis- 
utilities are  reduced  to  abstinence  and  waiting  (if  these  should 
be  distinguished),  they  are  very  precisely  expressed  in  the  income 
received.*  In  those  cases,  however,  where  much  change  is  in- 
volved, the  correspondence  of  income  and  disutility  is  of  course 
much  less  perfect.  But  it  is  by  no  means  wanting  even  here.  If 
the  prospects  of  change  do  not  involve  serious  uncertainty,  the 

*Of  course  this  applies  only  on  condition  that  the  land  has  changed 
hands  by  purchase  since  the  existing  rent  came  to  prevail. 

387 


PRINCIPLES  OF  ECONOMICS 

case  is  little  different  from  an  unchanging  one.  A  pretty  certain 
prospect  of  increasing  income  will  cause  a  corresponding  rise 
in  the  capitalization,  and  vice  versa.  Where  there  is  much  un- 
certainty and,  so,  much  risk,  this  fact  will  be  treated  as  a 
diminution  of  the  net  income,  and,  in  consequence,  the  capitali- 
zation and,  so,  the  disutility  assumed  will  be  lowered. 

Section  J.     Real   vs.   Apparent  Incomes. 

Up  to  this  point  in  our  discussion  of  incomes,  we  have 
ignored  altogether  the  possibility  of  a  discrepancy  between  the 
seeming  income  and  the  real  one.  But  a  very  little  reflection 
will  show  that  there  is  such  a  possibility.  In  the  great  majority 
of  cases,  apparent  incomes  are  in  the  form  of  money.  But  the 
buying  power  of  money  may  be,  and  surely  is,  very  different  in 
different  places  and  in  the  same  place  at  different  times.  Further, 
to  get  the  really  effective  income  which  a  man  enjoys,  as  such 
words  are  commonly  understood,  various  other  additions  or  de- 
ductions have  to  be  made,  even  if  we  have  made  allowance  for 
the  differences  in  the  purchasing  power  of  money.  Accordingly. 
it  seems  necessary  to  call  attention  to  certain  discrepancies  be- 
tween apparent  and  real  incomes. 

1.     Income  as  Affected  by  Prices. 

(a)  Any  cause   which  tends   to   raise   the   prices   of  partic- 
ular goods  tends  thereby  to  lower  the  incomes  of  all  consumers 
of  such  goods     other  than  those  consumers  who  are  also  pro- 
ducers of  said  goods. 

One  of  the  most  familiar  applications  of  this  is  the  case  of 
monopoly.  The  greatest  significance  of  monopoly  as  modifying 
distribution  is  in  that,  by  raising  prices,  it  reduces  the  volume 
of  our  real  incomes,  i.e.,  the  sum  of  goods  which  we  may  enjoy. 
Another  case  illustrating  how  causes  which  affect  the  prices  of 
particular  goods  lower  real  incomes,  is  the  indirect  tax  which, 
by  adding  to  the  outlay  of  the  producer,  causes  price  to  rise. 
A  noteworthy  feature  of  this  case  is  the  fact  that  a  tax  on 
imports  makes  a  higher  price,  not  only  for  the  imported  part  of 
the  goods  consumed,  but  also  for  the  part  produced  at  home. 
Still  another  important  caus'e  which  modifies  real  incomes  by 
affecting  particular  prices  is  improvement  in  methods  of  pro- 
duction whereby  costs  and  so  prices  are  reduced. 

(b)  If  for  any  cause  there  is  a  change  in  the  general  level 


CHAPTER   XIII.    SYSTEM    OF   DISTRIBUTION. 

of  prices,  this   fact  is   likely  to   modify  more  or  less  the  real 
incomes  of  people. 

Some  pages  back  we  pointed  out  that  changes  in  the  genera' 
price  level  are  likely  to  affect  favorably  or  unfavorably  one  sort 
of  income, — profits.  The  process  brought  out  in  that  case  di- 
rectly affects  money  income.  But  such  changes  in  general  prices 
may  also  modify  real,  as  compared  with  money,  incomes.  A 
general  rise  in  prices  obviously  lowers  the  buying  power  of  a 
given  money  income.  Now,  if  particular  money  incomes  are 
absolutely  or  relatively  fixed,  the  corresponding  real  income  is 
reducoA  The  worst  cases  are  those  of  annuitants,  pension- 
receivers,  and  persons  depending  on  contractual  interest  for 
their  incomes.  Next  come  the  case  of  persons  whose  income 
consists  of  fees;  for  these,  if  not  legally  fixed,  are  anyhow 
slow  to  change.  Salaried  persons  are  next  to  suffer;  for 
salaries  as  a  rule  change  very  slowly.  The  case  of  wage- 
earners  is  hardly  less  serious;  since  the  rate  of  wages  responds 
only  with  difficulty  to  changing  conditions.  Thus,  the  upward 
price  movement  consequent  upon  the  paper  money  inflation  oi 
the  American  civil  war  reached  its  maximum  for  commodities 
in  1865,  but  for  labor  the  date  was  1872. 

2.     Incomes  as  Affected  by  Taxation. 

It  is  evident  that,  if,  after  a  man  has  come  into  possession 
of  his  money  income,  government  either  directly  or  indirectly 
takes  from  him  some  portion  of  that  income,  his  final  income 
of  gratifications  of  the  ordinary  sort  is  thereby  curtailed.  This 
must  not  be  understood  as  implying  that  payments  to  govern 
ment  are  in  no  sense  correlated  to  a  real  income  to  the  tax- 
payer. The  expenditures  of  government  are  surely  of  advan- 
tage to  the  citizen;  and,  for  some  purposes,  the  citizen  ought  to 
think  of  his  contribution  to  that  expenditure  as  a  thoroughly 
legitimate  and  important  part  of  his  personal  budget.  Still,  it 
is  quite  impossible  to  deny  that  we  can  not  rationally  describe 
payments  to  government  as  the  purchase  price  of  services  ren- 
dered, in  the  sense  that  we  use  these  terms  when  speaking  of 
payments  to  the  grocer  or  the  drygoods  dealer.  It  is  quite 
impossible  to  form  any  rational  theory  of  the  ethics  of  present- 
day  taxation  except  by  recognizing  that  taxes  constitute  a  con- 
tribution which  it  is  our  duty  to  make,  and  the  government's 
duty  to  exact  from  us,  in  order  that  certain  general,  public, 

389 


PRINCIPLES  OF  ECONOMICS 

ends  may  be  accomplished, — ends  in  which  it  is  often  extremely 
difficult  to  trace  the  particular  personal  advantage  of  the  tax- 
payer. For  our  present  purpose,  therefore,  it  seems  legitimate 
to  look  on  taxation  as  cutting  down  our  real  incomes. 

Starting  from  this  viewpoint,  we  should  probably  find  that 
taxation  tends  to  modify  somewhat  the  distribution  which  would 
naturally  result  from  the  free,  spontaneous  working  of  economic 
forces,  but  that  its  influence  would  be  smaller  than  at  first 
thought  one  might  expect.  In  fact,  a  large  body  of  economists 
would  be  disposed  to  say  that  a  system  of  taxation  which  con- 
tinued substantially  unchanged  throughout  long  periods  would 
have  almost  no  modifying  effect  on  distribution.  Such  a  system 
would  simply  be  one  of  the  fundamental  conditions  under  which 
the  service-value  principle  would  work  itself  out.  But,  how- 
ever this  may  be,  we  all  know  that  systems  of  taxation  can  not, 
and  do  not,  remain  unchanged  for  indefinite  periods.  Now,  no 
one  pretends  that  the  shifting  of  taxes  so  as  to  bring  about  the 
same  relative  distribution  as  would  have  prevailed  without  them, 
is  an  easy  matter  which  can  be  accomplished  in  a  few  months 
or  anyhow  in  a  very  few  years.  Rather  it  may  consume  the 
life  of  a  generation.  This  being  the  case,  it  is  of  importance  to 
ascertain  some  of  the  effects  on  distribution  which  sooner  or 
later  will  be  felt,  and,  if  desirable,  guard  against  these.  We 
will  here  call  attention  to  only  two  or  three  considerations. 

(a)  It   is  usually  admitted  that  indirect  taxes,   e.g.,   import 
duties   and    excises,   if   levied   in   such   a   way   as   to   be    greatly 
productive,  fall  relatively  with  greater  weight  on  small  incomes 
than  on  large  ones. 

(b)  A  general  property  tax  affects  the  incomes  of  persons 
owning  visible  property  much  more  than  the  incomes  of  owners 
of  bonds,  stocks,  etc. 

(c)  A  land  tax  of  long  standing  does  not  constitute  a  bur- 
den on   any  private  income,   being  in   effect  a   rent-charge  paid 
to  the  government  as  part  owner  of  the  land.      (The  present 
owner  did  not  buy,  and  does  not  own,  an  exclusive  property  in 
the  land.) 

3.  Effective  or  Consumptional  Income  as  Contrasted  with 
Absolute  Income. 

We  have  already  noted  various  deductions  which  must  be 
made  from,  or  additions  which  must  be  made  to,  one's  apparent 
income  before  we  can  know  what  the  real  income  is. 
Another  set  of  deductions  or  additions  are  suggested  by  setting 

390 


CHAPTER   XITI.    SYSTEM    OF   DISTRIBUTION. 

ronsumptional  over  against  absolute  income.  When  people  speak 
with  indignation  of  the  excessive  incomes  of  the -very  wealthy, 
they  usually  are  directing  their  attention  to  the  fact  that  people 
of  wealth  enjoy  so  much  more  than  their  neighbors  of  the  good 
things  of  life,  fine  foods,  beautiful  furniture,  automobiles,  travel, 
etc.  In  short  they  have  in  mind  their  consumptional  income, — 
what  they  consume,  in  the  popular  meaning  of  the  word,  i.e.,  for 
their  immediate  gratification.  Now,  it  is  hardly  necessary  to 
say  that,  when  incomes  are  conceived  this  way,  there  is  much 
less  difference  between  those  of  the  rich  and  poor  than  seems 
on  the  surface  to  exist.  The  man  whose  apparent  income  is, 
say,  $100,000  consumes  in  the  ordinary  sense  perhaps  only 
$20,000  worth  of  goods,  the  remaining  $80,000  being  invested 
and  devoted  to  further  production.  Of  course  this  new  invest- 
ment will  increase  his  absolute  income.  But  what  if  it  does? 
He  very  likely  does  not  care  to  alter  materially  his  habits  of 
living.  He,  therefore,  has  no  use  for  the  increase  except  to 
invest  it  in  turn.  Thus,  as  respects  his  total  of  income,  with 
the  exception  of  $20,000  a  year,  the  rich  man  in  question  may 
be  conceived  as  a  sort  of  steward  for  society  at  large,  paid  a 
good  commission  indeed,  but  after  all  only  a  steward.  His 
income  in  the  ordinary  sense,  his  enjoyment  of  goods,  is  not 
100  times  that  of  the  man  who  earns  $1,000  and  spends  it  all 
on  every  day  consumption,  but  only  20  times. 

The  above  discussion  brings  out  the  point  that  if  we  are  trying 
to  realize  the  real,  effective  difference  in  the  incomes  of  the 
rich  and  the  poor,  we  must  for  most  purposes  deduct  from 
the  incomes  of  the  rich  the  part  put  into  further  production. 
As  a  complement  to  this  point  it  is  to  be  noted  that,  in  order 
to  realize  just  how  great  is  the  real,  effective  income  of  the 
poor,  we  must  add  a  large  number  of  gratuitous  and  semi- 
gratuitous  goods  which  under  modern  conditions  are  supplied 
to  them.  Especially  notable  are  the  means  of  education  and 
amusement  which  are  furnished  so  liberally  at  public  expense. 

Section  K.     Incomes  as  Affected  by  Non-Economic  Forces. 

We  have  seen  that  incomes  generally  are  determined  by  the 
laws  of  value  or  price,  i.e.,  by  economic  forces.  But  no  one 
doubts  that  other  forces,  custom,  altruism,  nepotism,  fraud,  etc., 
come  into  the  case,  and,  indeed,  play  a  very  large  part.  Some 

391 


PRINCIPLES  OF  ECONOMICS 

of  these  forces  work  to  increase  the  inequality  natural  to  a  com- 
petitive order;  others  work  to  diminish  that  inequality. 

Among  the  non-economic  forces  tending  to  diminish  inequality, 
or,  as  most  people  would  say,  to  improve  on  a  strictly  com- 
petitive order,  we  have  all  sorts  of  employers'  philanthropies, 
profit-sharing,  co-operation,  a  vast  system  of  charities,  large  en- 
dowments to  meet  all  sorts  of  needs,  and  so  on. 

Over  against  these,  leading  to  an  intensification  of  the  in- 
equalities natural  to  the  present  order,  we  have  a  great  array 
of  powerful  forces,  predatory  competition,  favoritism,  breach  of 
trust,  nepotism,  stock- jabbing,  frauds  of  all  kinds,  and  so  on. 

Section  L.     The  System  under  which  Possessions  are  Dis- 
tributed. 

It  is  evident  that  three  of  the  four  economic  incomes,  profits, 
interest,  and  rent,  connect  themselves  with  property, — are  de- 
rived from  property.  It  follows  that  back  of  the  determination 
of  incomes,  immediately  considered,  must  lie  the  distribution  of 
property.  We  understand  the  theory  of  these  incomes  only  in 
part,  if  we  stop  with  the  study  of  them  as  put  off  by  land  and 
capital.  We  ought  to  go  deeper  and  explain  the  distribution  of 
ownership  in  land  and  capital.  At  present  it  is  out  of  the  ques- 
tion for  us  to  do  this  at  all  adequately;  but  a  few  comments 
seem  to  be  demanded. 

1.  First,  in  so  far  as  possessions  are  derived  from  one  or 
more  of  the  four  regular  incomes,  and  this  covers  not  a  little 
of  the  case  still,  it  must  be  remembered  that  large  properties  can 
be  built  up  only  through  saz'ing.  In  this  respect  there  has  been 
no  essential  change  from  primitive  times.  Thrift,  economy,  is 
still  the  essential  condition  of  great  wealth,  great  possessions. 
With  fortunes  well  started,  thrift  does  not  of  course  involve 
great  privation.  Nor  was  this  ever  the  case;  it  is  only  the  very 
beginnings  of  a  fortune  which  involve  such  privation.  But 
thrift,  economy,  keeping  within  one's  income,  must  always  be 
essential;  for  the  arts  of  consumption  have  never  failed  sub- 
stantially to  keep  pace  with  those  of  production.  Wanton  ex- 
travagance can  never  consist  with  the  building  of  great  fortunes. 

Of  all  the  regular  sources  of  income,  profits  have  in  our  day 
doubtless  had  the  largest  share  in  the  creation  of  fortunes.  This 
is  using  profits  quite  broadly  to  include  all  the  gains  which  go 
to  the  people  who  assume  the  risks  of  ownership.  Some  of  the 

392 


CHAPTER    XIII.     SYSTEM    OF    DISTRIBUTION. 

most  important  cases  are  (a)  profits  derived  from  the  exploita- 
tion of  stores  of  natural  wealth,  (b)  profits  from  the  exploita 
tion  of  new  inventions,  (c)  profits  from  monopolies,  partial  or 
complete,  (d)  profits  from  unearned  increments,  increases,  in 
values  due  to  changes  for  which  the  owners  of  the  properties  in 
question  are  not  responsible,  and  (e)  profits  from  industrial  re- 
organization. 

2.  In  the  second  place,  the  maintenance  of  great  fortunes 
must  always  depend  in  considerable  measure  on  the  practice  of 
thrift.    This,  of  course,  does  not  mean  serious  privation  of  any 
sort,    but    only   a    firm    adjustment    of    expenditure    to    income. 
Reckless    extravagance   can   dissipate  the   greatest   of    fortunes. 
This    fact    has    always    been    accounted    a    sufficient    safeguard 
against   the    dangerous    concentration   of   wealth   made   possible 
through   inheritance.     The  extravagance  of  heirs,   it  is   argued, 
can  always  be  depended  upon  to  dissipate  extraordinary  wealth 
in   one  or   two   generations.     This    generalization   has    probably 
been  a  great  deal  overstated.     It  would  not  be  difficult  to  point 
out  families  which  have  retained  wealth  for  several  generations 
and  bid  fair  to  continue  the  experience. 

Note.  The  ordinary  view  of  the  case  seems  to  overlook  one 
phase  of  this  dissipation  of  fortunes  which  deserve  comment. 
Doubtless  the  diminished  inequality  of  fortune,  the  passage  of  a 
great  productive  property  into  abler  hands,  as  well  as  other 
results  of  the  supposed  dissipation,  are  of  real  advantage  to 
society.  But  it  should  not  be  forgotten  that  these  have  a  cost. 
There  is  a  real  squandering  of  wealth,  a  reckless,  wanton,  con- 
sumption of  society's  resources,  not  a  mere  shifting  of  property 
rights.  The  spendthrift  destroys  as  much  wealth  as  that  which 
he  transfers  to  others,  save  in  so  far  as  he  is  cheated. 

3.  Inheritance  always  has  played,  and  still  plays,  a  very  great 
part  in  determining  the  distribution  of   possessions.     Obviously 
its  significance  is  chiefly  dependent  on  the  particular  laws  and 
customs  which  obtain  in  any  time  and  place.    The  general  tend- 
ency of  present  day  legislation  is  to  diminish  the  part  played  by 
inheritance. 

(a)  In  earlier  times,  entail  was  used  to  maintain  an  unequal 
distribution  of  property.   Law,  or  custom  as  binding  as  law,  pro- 
hibited  the  breaking   up   of   estates   by   alienation   through   sale 
or  gift. 

(b)  Where   entail    is   no   longer   permitted,  settlement   may 
accomplish  something  like  the  same  result;  though  recent  legis- 
lation has  provided  for  the  practical  nullification  of  such  settle- 
ment. 

393 


PRINCIPLES  OF  ECONOMICS 

(c)  Primogeniture,  exclusive  inheritance  by  the  oldest  child, 
is  still  the  order  of  things  with  the  noble  families  of  England 
and,  of  course,  tends  to  perpetuate  the  existing  inequalities  more 
than  would  subdivision  among  several  children, 

(d)  In  contrast  with  entail,  settlement,  and  primogeniture, 
the  democratic  ideal  as  represented  by  modern  France  insists  on 
equal  division  among  the  children.     This   is   no   doubt  a   great 
improvement,   assuming  that  the  tendency  toward  inequality  is 
undesirable. 

(e)  In  our  day  the  legislation  which  seems   likely  to  mod- 
ify most  considerably  the  natural  distribution  of  wealth  is  the 
inheritance  tax.    This  has  already  been  developed  to  a  very  con- 
siderable   magnitude   and    is    everywhere    being   carried    further. 
In  Great  Britain,  it  amounts  to  nearly  10  per  cent  in  the  case  of 
direct  heirs  and  to  about  twice  as  much  for  the  more  remote 
collateral  heirs 

4.  In  the  United  States  one  of  the  most  important  sources 
of  great   fortunes    is   the  public — governmental — grant.     Under 
heading    1    above,    it    was    said    that    profits    derived    from    the 
exploitation  of  stores  of  natural  wealth  played  a  large  part  in 
building  up  fortunes.     But  the  opportunity  to  obtain  such  profits 
obviously  turns   on   the  ownership   or   control   of  land   and   the 
latter  in  turn  has  largely  been  obtained  through   governmental 
munificence  or  folly  in  granting  such  land.    Here  we  have  one 
of  the  greatest  abuses  in  American   industrial  evolution.     We 
have  squandered  the  patrimony  of  many  generations.   The  weak- 
ness of  government  in  a  new  and  republican  nation,  a  careless 
overestimate  oi  our  resources,  preoccupation  each  with  his  own 
affairs, — these    and    other    conditions    have    combined    to    make 
possible  a  reckless  profligacy  in  the  disposition  of  our  natural 
resources  which  future  generations  will  find  it  hard  to  compre- 
hend and  still  harder  to  forgive. 

It  should  doubtless  be  admitted  that  in  some  measure  public 
liberality  has  been  justified  as  part  of  the  price  of  our  extra- 
ordinarily rapid  development. 

5.  There  can  be  no  doubt  that  fraud  of  varying  kind  and 
degree  has  been  an  important  factor  in  determining  the  distri- 
bution of  property,  possessions.     Here  we  have  in  mind,  not  the 
fraud  which  enlarges  income  and  which  would  therefore  make 
possible  the   enlargement  of  possessions,   but  rather  the    fraud 
which    directly    adds    to    possessions,    e.g.,    getting    control    of 
valuable  timber  lands  belonging  to  the   state  by  illegal   means. 
Under  the  preceding  head,   we  noted  the   absurd    liberality   of 

394 


CHAPTER    XIII.     SYSTEM    OF    DISTRIBUTION. 

government  in  turning  over  public  property  of  incalculable  value 
to  private  persons  for  little  or  nothing.  The  evils  of  such  a 
policy  have  been  increased  in  no  small  degree  by  fraudulent 
practices.  By  the  collusion  of  legislators  and  public  officers, 
the  patrimony  of  the  state  has  been  stolen  on  a  gigantic  scale. 

Quite  as  notable,  perhaps,  has  been  the  stealing  of  franchises 
yielding  hundreds  of  millions. 

Even  in  the  lesser  relations  of  ordinary  business,  fraud  has 
played  no  inconsiderable  part.  Swindling  of  partners,  freezing 
out  weaker  stockholders,  violating  trusts,  etc.,  these  and  many 
other  forms  of  traud  are  constantly  practiced. 


395 


CHAPTER  XIV. 
A  CRITIQUE  OF  THE  EXISTING  ECONOMIC  ORDER. 

We  have  now  reached  the  end  of  our  purely  scientific  study 
of  the  economic  phenomena  of  the  present  order.  If  we  were 
dealing  with  a  group  of  phenomena  quite  removed  from  human 
control,  it  would  be  natural  to  stop  at  this  point.  But  we  hardly 
need  say  that,  with  respect  to  economic  phenomena,  no  such  state- 
ment couid  properly  be  made.  The  present  economic  order  is  in 
greater  or  less  measure  the  product  of  human  arrangements. 
As  such  it  must  be  presumed  to  be  formed  with  more  or  less  refer- 
ence to  the  accomplishment  of  ends.  Doubtless  one  may  easily 
exaggerate  the  power  of  individuals,  or  of  society  as  a  whole, 
to  alter  the  system  in  fundamentals.  But  so  long  as  this  power 
exists  in  any  degree,  indeed  so  long  as  people  commonly  believe 
that  it  exists,  students  of  economics  will  feel  called  upon  to  con- 
sider the  fitness  of  the  present  order  to  attain  the  ends  for  which 
it  must  be  presumed  to  exist.  To  this,  however,  some  may  object 
that,  although  such  a  problem  as  that  indicated  is  surely  presented 
by  the  situation,  still  the  economist  as  such  is  not  called  on  to 
attempt  its  solution.  Such  persons  would  perhaps  say  that  eco- 
nomics, being  a  science,  has  to  do  only  with  what  is,  not  with 
what  ought  to  be;  consistency,  therefore,  requires  the  economist 
to  leave  the  critique  of  the  present  order  to  some  other  class  of 
persons,  say,  the  sociologist  or  the  publicist  or  the  philosopher. 
There  is  no  doubt  force  in  this  contention.  It  is  to  be  remem- 
bered, however,  that  there  is  a  degree  of  deference  to  logical 
consistency  which  savors  of  pedantry.  In  every  field  there  arise 
problems  having  a  mixed  character, — problems  dependent  for 
their  solution  on  data  derived  from  various  sciences.  These 
problems  must  be  discussed  somewhere,  which  means  that  one, 
at  least,  of  the  sciences  interested  must  transcend,  in  some  meas- 
ure, its  natural  boundaries.  Now,  it  would  seem  that  the  science 
which  we  would  naturally  choose  for  this  office  is  that  one  from 
which  the  larger  number  and  the  more  difficult  of  the  data  neces- 
sary to  a  solution  must  be  obtained.  In  the  case  before  us,  this 
condition  is  surely  realized  by  economics. 

396 


CHAPTER  XIV.    CRITIQUE  OF  PRESENT  ORDER 

In  further  support  of  this  contention  that  economics  should 
undertake  the  task  of  ascertaining  whether,  and  how  far,  the 
present  economic  order  attains  the  ends  for  which  it  exists,  we 
may  remark  that  such  practice  is  on  the  whole  in  accord  with 
tradition.  Economists,  whatever  their  initial  professions,  have 
seldom  failed  to  discuss  the  working  of  the  system  from  the 
teleological  standpoint,  and  even  to  argue  for  or  against  proposed 
changes,  and  it  is  probable  that  the  instructed  public  give  more 
weight  to  the  verdicts  of  economists  in  respect  to  these  matters 
than  to  those  of  any  other  class. 

Note :  In  maintaining  .the  foregoing  contention,  we  do  not 
mean  to  suggest  that  moralists,  sociologists  et  al.  should  be 
estopped  from  discussing  how  far  the  present  order  is  a  success 
or  a  failure.  We  merely  wish  to  insist  that  the  economist  can 
properly  enough  essay  this  task. 

In  the  preliminary  account  of  the  existing  order  with  which 
this  course  began,  that  order  was  represented  as  a  coherent, 
rational  whole, — a  system  having  different  parts  devoted  to  dif- 
ferent functions,  all  co-ordinated  into  a  great  harmonious  totality. 
At  the  same  time,  however,  it  was  represented  that  the  organiz- 
ing and  regulating  of  this  great  totality  was  not  conscious,  but 
spontaneous,  automatic.  Further,  we  saw  that  the  particular 
economic  process  having  most  part  in  automatically  creating 
the  great  whole  and  regulating  its  operations,  is  exchange.  Still, 
again,  it  was  brought  out  that  the  particular  part,  element,  in 
exchange  which  has  most  to  do  in  regulating  the  organization  as 
a  whole,  is  value,  price.  More  particularly,  it  was  explained  that 
it  is  price  chiefly  which  determines  what  things  shall  be  produced, 
how  things,  when  produced,  shall  be  utilized,  and  what  propor- 
tion of  the  total  product  shall  fall  to  the  different  participants 
in  socialized  production.  In  the  present  chapter  we  try  to  answer, 
not  exhaustively,  but  with  greater  fulness  than  heretofore,  the 
question  :  How  far  is  this  automatically  regulated  economic  sys- 
tem a  success  in  attaining  the  ends  for  which  it  must  be  supposed 
to  exist?  Does  it  secure  fairly  satisfactory  results — as  good 
results,  anyhow,  as  it  is  reasonable  to  look  for — in  respect  to 
production,  consumption,  and  distribution? 

In  view  of  the  tone  of  many  previous  allusions  to  this  ques- 
tion, it  is  hardly  necessary  to  say  that  the  answer  offered  in  this 
chapter  IB  on  the  whole  an  affirmative  one.  Broadly  speaking, 
we  look  on  the  existing  economic  order  as  measurably  realizing 
the  ideals  which,  considering  the  limitations  of  human  nature, 

397 


PRINCIPLES  OF  ECONOMICS 

it  is  reasonable  to  demand  from  such  a  system.  But  in  taking 
this  position  we  wish  to  disclaim  in  the  most  emphatic  language 
any  intention  of  representing  the  present  order  as  a  perfect  one, 
either  theoretically  or  practically.  Its  ideals  are  below  the  highest, 
though  necessarily  so  as  we  think;  and  its  practice  is  at  many 
points  far  below  its  ideals.  Many  of  its  failures  grow  out  of  the 
limitations  of  human  nature;  but  not  a  few  are  needless, — can 
be  avoided.  Increased  interference  with  the  actual  working  of 
things,  both  through  private  and  governmental  initiative, — if  for 
no  other  purpose  than  to  eliminate  elements  which  are,  and  always 
have  been,  inconsistent  with  the  system, — is  imperatively  de- 
manded. Further,  there  can  be  no  doubt  that  a  degree  of  gov- 
ernmental interference  which  goes  much  beyond  this,  whicn 
limits  sharply  the  free  working  of  those  conditions  which  are 
most  characteristic  of  the  present  order,  ought  to  be,  and  will  be, 
forthcoming  in  the  near  future.  Whether  in  the  interest  of 
society  as  a  whole  or  of  those  individuals  on  whom  the  existing 
system  presses  too  hardly,  we  shall  doubtless  see  a  more  exten- 
sive resort  to  governmental  initiative,  a  greater  limitation  of  the 
rights  of  property,  a  further  restricting  of  the  rights  of  inherit- 
ance and  bequest,  a  distribution  of  tax  burdens  far  more  favor- 
able to  the  poor,  public  provision  for  old  age  pensions,  and  so  on. 
In  a  word,  when  we  defend  the  existing  order  we  merely  mean 
to  affirm  that  that  order  is  in  its  main  outlines  substantially 
sound,  fitted  to  attain  the  reasonable  ends  for  which  such  an 
order  exists.  Looked  at  broadly,  it  shows  itself  to  be  highly 
efficient  and  as  much  in  accord  with  our  moral  ideals  as  we 
could  expect  in  view  of  human  weakness,  folly,  and  wickedness. 
The  general  plan  of  exchange-cooperation,  involving  private 
rather  than  public  initiative,  characterized  by  private  property 
in  capital  and,  for  most  purposes,  in  land,  with  production,  con- 
sumption, and  distribution  regulated  in  general  through  a  price 
resulting  from  free  economic  action,  is  more  likely  than  any 
fundamentally  different  scheme  to  work  in  a  measurably  satis- 
factory fashion.  Increased  regulation  and  a  more  liberal  admix- 
ture of  socialistic  elements  may  improve  things;  but  the  general 
system,  the  main  framework,  is  sound  and,  as  human  affairs 
go,  adequate. 

Section  A.     The  Present  Order  and  Production. 

It  would  probably  be  admitted  by  well-nigh  every  one  that, 

398 


CHAPTER  XIV.    CRITIQUE  OF  PRESENT  ORDER 

in  respect  to  production,  the  present  system  works  fairly  well, — 
anyhow  is  less  defective  than  in  respect  to  distribution.  The 
socialist,  it  is  true,  lays  considerable  stress  on  certain  deficiencies 
at  this  point;  but  most  scientific  students  would  probably  con- 
sider his  criticisms  much  exaggerated.  Even  the  socialist  would 
admit  that  a  better  case  for  the  defense  is  possible  here  than 
elsewhere. 

The  chief  characeristics  which  we  naturally  demand  in  a  pro- 
ductive system,  if  it  is  to  be  adjudged  reasonably  satisfactory 
are:  (l)  that  its  product  should  be  large — the  largest  possible 
from  the  resources  available;  (2)  that  the  said  product  should 
be  good, — the  best  possible,  considering  the  resources;  (3)  that 
it  should  be  adjusted  to  wants;  and  (4)  that  production  as  a 
process  should  be  as  free  as  possible  from  marked  irregularities, 
perturbations. 

How  far  does  the  present  system  display  these  characteristics? 
Beginning  with  the  fourth,  it  must  be  admitted  that,  at  the  pres- 
ent time,  our  system  is  not  very  satisfactory.  It  is  a  familiar 
fact  that  production  is  subject  to  marked,  almost  violent,  fluctu- 
ations, which  naturally  group  themselves  into  the  so-called  indus- 
trial cycle:  depression,  recovery,  increasing  activity,  normal 
activity,  over-trading,  crisis,  collapse,  depression,  and  so  on.  The 
claim  of  the  socialist  that  public  initiative  would  almost,  if  not 
quite,  eliminate  this  sort  of  thing  is  surely  a  fairly  reasonable 
one.  Anyhow,  socialism  would  be  certain  to  work  better  at  this 
point  than  does  the  present  system.  We  do  not,  however,  admit 
that  this  settles  the  matter.  The  fact  is  that  the  industrial  cycle, 
in  its  serious  forms,  is  a  comparatively  modern  disease, — not 
much  more  than  a  century  old.  Further,  even  socialists  admit 
that  much  has  already  been  done  to  bring  it  under  control. 
America,  for  reasons  easy  to  trace,  is  still  much  subject  to 
attack.  But  England,  the  original  home  of  great  panics,  has  had 
no  serious  crisis  since  1866.  In  short,  the  leaders  of  industry 
are  learning  to  control  things  sufficiently  to  safeguard  against 
this  trouble  or,  anyhow,  to  palliate  greatly  its  evils.  Accordingly, 
it  would  surely  be  foolish  at  the  present  time  to  pronounce  a 
verdict  against  the  present  order  on  account  of  the  defect  in 
question. 

Turning,  now,  to  the  first  three  of  the  characteristics  which 
can  properly  be  required  from  a  good  productive  system,  it 
seems  certain  that  a  favorable  verdict  must  be  given  for  the 

399 


PRINCIPLES  OF  ECONOMICS 

present  order.  If  we  are  looking  for  an  order  which  insures 
abundant  products,  good  products,  and  products  which  corre- 
spond to  demand,  the  present  one  can  surely  give  a  good  account 
of  itself, — far  better,  probably,  than  could  any  substitute  which 
should  depend  on  public  initiative.  Take  the  first  two  matters, 
abundance  and  goodness  of  products.  As  respects  fitness  to 
secure  these  results,  the  present  system  supplies  conditions  which 
seem  almost  theoretically  ideal  in  that  it  makes  each  man's 
income  conditioned  upon  the  price  of  his  contribution,  then  estab- 
lishes the  freest  possible  market  for  those  particular  contribu- 
tions which  are  bought  and  sold1 — labor  services,  capital  services, 
and  land  services, — and,  finally,  in  respect  to  the  remaining  factor 
— responsibility-taking, — it  permits  the  almost  untrammeled  initia- 
tive of  the  individual.  Now,  making  incomes  dependent  on  con- 
tribution and  maintaining  a  free  market  for  land,  labor,  and 
capital  services  means  that  these  are  forthcoming,  in  so  far  as 
this  is  dependent  on  human  choice,  in  the  greatest  possible  abund- 
ance, and  that  they  are  inevitably  put  to  the  most  profitable  uses, 
i.  e.,  that  they  are  assigned  to  the  places,  combinations,  where 
they  will  add  most  to  product.  In  like  manner,  the  regulation 
of  income  in  accord  with  contribution,  combined  with  free  private 
initiative  in  respect  to  undertaking,  means  an  initiative  the  most 
alert,  bold,  energetic,  and  informed  that  one  can  well  imagine. 
It  is  quite  incredible  that  government  should  supply  an  initiative 
at  all  comparable  in  these  particulars. 

The  above  verdict  with  respect  to  the  productive  efficiency 
of  the  present  order  is  concurred  in  by  almost  all  economists. 
Yet  perhaps  a  moment's  consideration  should  be  given  to  the 
opposing  contention  of  socialist  critics  that  this  order  is  not  even 
productively  successful.  In  support  of  this  idea  they  bring  for- 
ward three  considerations  chiefly:  the  wastes  of  competition,  the 
idleness  of  the  parasitic  classes,  and  the  sacrifice  of  utility  to 
value.  In  respect  to  the  first  of  these  it  is  to  be  said  that  there 
are  undoubtedly  wastes  in  a  system  of  free  private  initiative, — 
though  their  amount  is  grossly  exaggerated, — but,  in  the  opinion 
of  the  economist,  this  so-called  waste  is  merely  the  cost  of  a 
rarely  efficient  initiative,  and  a  low  cost  at  that.  For  all  students 
of  business  organization  agree  that  the  monopolistic  and  quasi- 
monopolistic  business  units  are  much  less  efficiently  organized 
today  than  are  the  units  exposed  to  free  competition. 

Again,    we    cannot   taKe    more    seriously    the    talk    about    the 

400 


CHAPTER  XIV.    CRITIQUE  OF  PRESENT  ORDER 

wasted  productive  capacities  of  the  parasitic  classes.  To  start 
with,  their  number  is  absurdly  exaggerated.  A  large  proportion 
of  the  persons  so  designated  are  performing  functions  which  are 
essential  to  high  productive  efficiency.  In  the  second  place,  it 
seems  certain  that,  if  they  all  were  to  become  producers  in  the 
socialist  sense,  the  amount  which  they  would  add  to  the  income 
of  each  person  would  be  scarcely  appreciable. 

Finally,  in  respect  to  the  third  objection  of  the  socialist,  he 
seems  to  economists  to  be  seriously  in  error.  As  at  not  a  few 
other  points,  he  has  made  a  mountain  out  of  a  molehill.  There 
is  no  doubt  the  possibility  of  a  contradiction  between  utility  and 
value.  That  is,  one  who  is  seeking  only  to  increase  values  may 
find  himself  in  a  position  wKere  he  would  better  diminish  output 
and  so  diminish  utilities ;  and,  since  the  immediate  return  to  pro- 
ducers is  a  value  return  rather  than  a  utility  one,  viz.,  purchasing 
power  in  the  form  of  money,  it  naturally  follows  that  producers 
will  find  themselves  in  a  position  where  they  can  gain  most  by 
reducing,  or  at  least  checking,  the  increase  of  utilities.  But, 
now.  it  is  surely  evident  that  the  adoption  and  pursuit  of  such  ? 
policy  as  that  indicated  is  possible  only  through  concert  of  action 
among  producers;  since  values  can  be  increased  by  limiting  out- 
put, only  provided  it  is  the  total  output  which  is  thus  limited,  not 
merely  that  oi  some  producers.  But  concert  of  action  among 
producers  is  in  contradiction  to  the  very  essence  of  the  present 
order  of  which  untrammeled  private  initiative  is  the  dominant 
feature.  Accordingly,  it  is  quite  illegitimate  to  represent  this 
order  as  one  in  which  it  is  inevitable  that  producers  should  seek 
to  increase  values  to  the  neglect,  or  even  the  destruction,  of 
utilities.  Increase  of  values  is  doubtless  the  natural  goal  of  the 
producer  as  producer;  but,  under  a  regime  of  free  competition, 
the  only  path  by  which  that  goal  can  be  attained  is  the  increase 
of  utilities. 

We  have  seen  that  the  present  regime  is  eminently  adapted 
to  insure  that  products  shall  be  abundant  and  good.  We  have 
still  to  remark  on  the  fitness  of  the  present  system  so  to  guide 
production  that  products  will  correspond  to  wants,  need.  In 
one  sense  of  these  words  all  would  at  once  admit  that  this  requi- 
site is  surely  realized  in  the  present  order.  Free  private  initiative 
combined  with  a  free  market,  if  capable  of  nothing  else,  is  surely 
capable  of  adjusting  output  to  wants.  "But  just  here,"  the  ob- 
jector will  say,  "we  strike  a  serious  ambiguity.  The  adjustment 

401 


PRINCIPLES  OF  ECONOMICS 

ro  wants,  which  takes  place  in  the  present  order,  is  an  adjust- 
ment to  those  wants  which  express  themselves  in  economic 
demand,  and  those  wants  may  or  may.  not  correspond 
to  real  social  wants.  In  the  case  of  the  wants  of  the  man  who 
has  money  and  can,  therefore,  contribute  to  economic  demand, 
the  present  order  will  insure  a  production  which  provides  for 
those  wants;  but  how  about  the  wants  of  the  man  who  is  with- 
out the  buying  power?  These  wants  are  surely  far  more  real 
and  serious  than  the  wants  of  the  rich  man.  But,  obviously, 
no  one  can  contend  that  the  present  order  insures  that  produc- 
tion shall  be  so  guided  as  to  provide  for  these  wants." 

Now,  the  above  represents  an  objection  to  the  present  order 
of  much  significance.  But  it  is  really  an  objection  to  the  work- 
ing of  that  order  in  respect  to  distribution  rather  than 
in  respect  to  production.  If  price  is  to  serve  at  all  as 
a  regulator  of  production,  the  money  incomes  of  individuals 
will  necessarily  be  unequal,  since  those  incomes  are  made 
up  of  the  prices  of  contributions  which  those  individuals 
are  in  a  position  to  make,  and  said  prices  are  bound 
to  be  unequal.  But  if  money  incomes  are  unequal,  the  power 
to  demand  goods,  economically  speaking,  and  so  the  power  to 
consume  goods  will  be  unequally  distributed.  But,  again,  the 
needs  to  which  production  ought  to  be  adjusted  are  surely  the 
needs  of  those  who  will  actually  consume, — any  other  interpre- 
tation would  be  nonsense.  It  follows,  then,  that  the  objection 
brought  out  above  is  really  an  objection  to  the  present  system 
in  respect  to  the  distribution,  rather  than  the  production,  which 
it  effects. 

Section  B.     The  Present  Order  and  Consumption. 

As  respects  the  regulation  of  consumption,  a  satisfactory 
system  needs  to  show  three  results  chiefly:  (1)  Those  natural 
resources  which  belong  to  society  as  a  whole  and  to  posterity 
must  not  be  sacrificed  to  the  selfish  greed  of  the  individual  and 
the  present;  (2)  The  satisfaction  of  immediate  wants  must  not 
absorb  all  our  producing  efforts  to  the  neglect  of  that  building 
of  capital  on  which  great  productive  efficiency  depends;  and  (3) 
The  best  utilization  of  a  stock  of  consumption  products  already 
existing  should  be  assured. 

With   respect  to   the   first  of   these   demands,   we   must   admit 
at  once  that  it  is  very  imperfectly  provided  for  in  the  present 

402 


CHAPTER  XIV.    CRITIQUE  OF  PRESENT  ORDER 

order.  Under  the  free  working  of  private  initiative,  the  vast 
resources  of  a  continent  in  lumber,  coal,  iron,  etc.,  are  being 
rapidly  dissipated,  and  that  in  too  large  measure  for  the  benefit 
of  very  small  classes.  Even  the  race  itself  has  been  threatened 
with  serious  deterioration  through  an  unbridled  use  of  liberty 
in  respect  to  the  employment  of  women  and  children;  so  that 
everywhere  governmental  interference  has  proved  a  necessity. 
All  this  is  natural  enough.  When  we  are  dealing  with  the 
interests  of  the  remoter  future,  it  is  only  within  quite  narrow 
limits  that  we  can  trust  the  forces  which  ordinarily  prove  effi- 
cient and  safe  regulators  of  economic  action  (see  Walker). 
The  safeguarding  of  those  interests  is  a  duty  which  from  its 
very  nature  rests  upon  the  group,  rather  than  the  individual. 
-  Unfortunately,  the  group  too  rarely  rises  above  the  standpoint 
of  those  individuals  who  are  economically  most  powerful  and 
greedy;  so  that  the  duty  of  the  group  at  this  point  is  too 
frequently  neglected.  Still  it  cannot  be  doubted  that  our  only 
hope  lies  in  this  direction.  Government  must  put  great  and  rigid 
limitations  on  private  initiative  at  this  point,  if  the  social  patri- 
mony is  to  be  saved  at  all. 

As  regards  the  second  requisite  of  a  system  which  properly 
regulates  consumption — that  it  should  not  permit  the  satisfaction 
of  immediate  wants  to  absorb  all  our  productive  efforts  to  the 
neglect  of  capital-building — our  present  system  can  give  an 
excellent  account  if  itself, — a  better  account,  probably,  than 
could  be  given  by  any  system  depending  on  public  initiative. 
Capital  increases  at  an  amazing  pace.  This  is  doubtless  not  a 
little  due  to  a  feature  of  the  system  which  is,  in  many  respects, 
undesirable,  viz.,  the  extreme  inequality  of  incomes,  which,  con- 
centrating so  much  in  the  hands  of  a  few,  makes  the  task  of 
saving  relatively  easy.  But  this  is  not  the  only  explanation. 
The  present  system  powerfully  stimulates  accumulation  in  that 
it  offers  to  those  who  save,  great,  rewards,  not  so  much  in  the 
shape  of  interest,  as  in  the  shape  of  those  profits  which  may  be 
obtained  by  the  skillful  use  of  a  small  initial  sum.  A  further 
reason  is  found  in  the  fact  that  the  present  system  supplies 
highly  convenient  and  efficient  machinery  for  assisting  the  pro- 
cess of  capital-building,  in  the  shape  of  savings  banks,  insurance 
companies,  bond  exchanges,  etc. 

As  regards  the  third  requisite, — the  best  utilization  of  an 
already  existing  stock  of  consumption  products, — the  present 

403 


PRINCIPLES  OF  ECONOMICS 

system  easily  meets  the  case,  save  under  quite  exceptional 
circumstances.  It  belongs  to  the  very  nature  of  the  laws 
of  exchange  to  establish  a  price  which  adjusts  demand 
to  stock, — reducing  demand,  if  stock  is  scanty,  by  raising  price. 
But  here,  again,  we  meet  the  objection  which  was  advanced 
when  we  were  discussing  the  fitness  of  the  present  system  to 
adjust  production  to  demand.  "Demand,"  it  is  said,  "is  adjusted 
to  stock  by  being  cut  down  through  higher  price ;  but  this 
means  that  the  demand  of  the  poor  falls  off,  while  that  of  the 
rich  keeps  at  its  old  level  "  Now  there  is,  no  doubt,  some  truth 
in  this;  still  it  must  not  be  taken  too  seriously.  In  the  first 
place,  the  statement  is  much  exaggerated.  Save  with  respect 
to  a  very  few  commodities,  indeed,  the  number  of  families  who 
do  not  reduce  consumption  at  all  when  price  rises  is  very  small, 
— so  small  that  its  continuance  of  the  old  scale  cannot  materially 
alter  the  result.  Secondly,  as  before  explained,  we  have  here 
an  objection  which  is  really  directed  against  the  distribution 
side  of  the  present  order,  and  so  is  not  germane  to  our  present 
discussion.  If  value,  price,  is  to  play  a  directive  role  in  the 
economic  order  inr.nmes  are  bound  to  be  unequal.  But  if  in- 
comes are  to  be  unequal,  then  the  relative  importance  which  we 
impute  to  wants  must  correspond  more  or  less  fully  with  this 
inequality;  i.  e.,  a  certain  want  felt  by  a  person  of  large  income 
must  be  recognized  as  more  important  than  the  same  want  ex- 
perienced by  a  person  of  smaller  income.  This  sounds  brutal, 
but  it  is  an  unavoidable  conclusion  from  the  premises,  as  was 
brought  out  in  the  closing  paragraph  of  the  preceding  section. 
As  it  is  "a  hard  saying"  and  yet  of  much  significance  in  con- 
nection with  our  present  task,  it  will  be  touched  upon  again  in 
the  next  section. 

Section   C.     The   Legitimacy   of    the   Distributive   Principle 

Supposed  to  be  Embodied  in  the  Present  Order. 
In  this  section  we  begin  the  study  of  one  of  the  most  import- 
ant questions  to  which  the  economist  addresses  himself:  Does 
the  present  order  work  out  a  reasonably  satisfactory  result  in 
respect  to  distribution?  In  undertaking  to  answer  this  question 
with  a  qualified  affirmative,  as  we  do  in  the  remaining  sections 
of  this  chapter,  we  would  again  disclaim  any  purpose  to  contend 
that  the  present  system  of  distribution  even  tends  to  be  ideally 
perfect,  much  less  that  it  actually  is.  We  freely  admit  that  the 

404 


CHAPTER  XIV.    CRITIQUE  OF  PRESENT  ORDER 

principle  which  it  tries  to  realize  is  far  below  the  best  conceiv- 
able ideal,  that  our  present  order  tries  to  carry  out  this  principle 
while  maintaining  institutions  which  inevitably  increase  the 
evils  which  would  in  any  case  follow  the  application  of  the 
principle,  and,  finally,  that  in  manifold  respects  the  results  are 
far  worse  than  they  need  to  be  even  under  the  full  operation  of 
the  principle  and  its  accompanying  institutions,  i.  e.,  great  im- 
provements are  needed,  are  possible,  and  ought  to  be  effected. 
Nevertheless,  we  hold  that  a  verdict  for  the  substantial  sound- 
ness of  the  present  order,  even  in  respect  to  the  distribution  it 
effects,  is  inevitable. 

Our  first  task  must  be  to  consider  the  general  principle  of 
distribution  which  is  supposed  to  be  embodied  in  the  existing 
order  and  ask  ourselves  whether,  in  general,  that  principle  is  a 
reasonable  one, — whether,  assuming  the  accompanying  condi- 
tions satisfactory,  that  principle  would  commend  itself  as,  on 
the  whole,  wise  and  just.  In  the  discussion  following,  this  ques- 
tion receives  an  affirmative  answer.  Let  it  be  remembered,  how- 
ever, that  in  giving  this  answer  we  do  not  thereby  affirm  the 
reasonableness  and  justice  of  the  principle  in  question  as  it  i-s 
actually  worked  out  in  the  present  economic  order.  In  that 
order,  land  and  capital  are  objects  of  private  ownership,  and  so 
their  product  is  credited  to  certain  individuals.  Obviously,  if 
land  and  capital  were  owned  by  the  state,  although  the  present 
principle  ot  distribution  continued  to  be  dominant,  the  results 
would  be  very  different  as  far  as  the  individuals  in  question  are 
concerned.  Again,  the  present  order  provides  for  an  almost 
untrammeled  right  of  inheritance.  Eliminating  this  condition, 
although  the  dominant  principle  was  left  unchanged,  would 
surely  cause  a  great  change  in  the  results. 

1.     What  is  the  Supposed  Distributive  Principle  of  the  Present 

Order? 

It  might,  perhaps,  be  presumed  that  the  answer  to  this  ques- 
tion has  been  given  sufficiently  often,  by  implication  at  least,  to 
make  its  repetition  in  this  connection  unnecessary.  In  order, 
however,  to  avoid  possible  misunderstanding  we  shall  set  forth 
the  principle  once  more.  Under  the  present  order,  when  compe- 
tition is  free,  each  tends  to  get  approximately  that  in- 
income  which  expresses  the  marginal  significance  of  the  natural 
supply  of  the  type  of  contribution  made  by  himself  or  his  prop- 

405 


PRINCIPLES  OF  ECONOMICS 

erty  to  the  sum  of  utilities,  and  which  at  the  same  time  expresses 
approximately  the  marginal  disutility,  original  or  derived,  in- 
volved in  making  said  contribution. 

2.     Some  Other  Possible  Principles  of  Distribution. 

It  is  scarcely  necessary  to  say  that  no  adequate  critique  of 
the  dominant  principle  of  distribution  can  be  effected  without 
some  contrasting  of  that  principle  with  possible  substitutes. 
Of  these  the  number  is  legion;  but  only  two  or  three  have  had 
serious  following. 

A.  Doubtless  the  most  ideal  principle  of  distribution  is  that 
which  we  try  to  realize  in  some  degree  in  the  family  life,  as 
also  in  the  life  of  the  state  in  the  periods  of  greatest  social 
exaltation.  I  mean  the  principle  that  each  shall  receive  of  the 
common  income  in  proportion  to  his  need, — having  given  in 
proportion  to  his  capacity.  This  seems  to  have  been,  and  to 
be  still,  the  formula  of  the  highest  type  of  communism.  "From 
each  according  to  his  capacity;  to  each  according  to  his  need!' 
To  the  present  writer  there  seems  no  room  for  argument  as  to 
the  ethical  superiority  of  this  distributive  ideal  over  all  others. 
If  human  nature  were  equal  to  the  maintenance  of  such  an 
ideal,  no  other  formula  would  deserve  a  moment's  consideration. 
But  surely  no  one  will  seriously  urge  this  as  a  possibility  for 
the  ninety  millions  of  men,  women,  and  children  who  constitute 
the  population  of  the  United  States.  Even  those  few  hundreds 
who  succeed  in  living  somewhat  near  such  an  ideal  in  Amana 
and  other  communistic  associations  admit  that  their  very  lim- 
ited success  is  made  possible  only  because  of  certain  very  in- 
tense religious  sentiments  which  are  common  to  all  the  members 
and  which  it  would  never  be  possible  to  find  in  more  than  a 
very  small  minority  of  the  population. 

B.  Next  to  the  need  ideal  of  distribution  comes  that  of 
equality.  To  each  an  equal  share,  but  from  all  service,  is  its 
motto.  This  is  the  more  usual  communistic  ideal.  It  is  ap- 
parently favored  by  many  socialists.  There  is  no  doubt  much 
to  be  said  for  it.  The  greatest  discomfort  from  poverty  is 
probably  due  to  the  contrast  with  the  position  of  more  favored 
neighbors.  As  a  matter  of  mere  sentiment,  I  sympathize  with 
those  persons  who  declare  themselves  willing  to  pay  the  price — 
the  inevitable  price — of  equality,  i.  e.,  an  equality  of  misery. 
But  after  all  it  is  quite  out  of  the  question.  Equality  in  income 

406 


CHAPTER  XIV.    CRITIQUE  OF  PRESENT  ORDER 

would  sacrifice  the  real,  material  welfare  of  all  classes  to  mere 
sentimental  considerations.  Further,  it  would  not  ev^.n  embody 
the  ethical  ideals  which  dominate  practically  the  whole  com- 
munity. For,  however  people  may  feel  toward  interest,  rent, 
and  profits,  they  almost  universally  believe  that  wages  and- 
salaries,  anyhow,  ought  to  bear  some  relation  to  service  rendered. 

But  this  is  too  important  a  matter  to  be  so  lightly  disposed 
of.  Are  we  right  in  saying  that  an  attempt  to  enforce  complete 
equality  would  sacrifice  the  real  material  welfare  of  all  classes 
to  mere  sentimental  considerations?  In  support  of  this  view, 
there  are  perhaps  three  chief  considerations:  (1)  In  the  first 
place,  there  are  not  a  few  cases  in  which  giving  some  persons 
larger  incomes  than  the  rest  of  us  may  properly  be  described 
as  directly  required  in  the  interests  of  the  rest  of  us,  in  that 
the  larger  incomes  are  necessary  to  enable  said  persons  to  per- 
form efficiently  the  important  tasks  we  have  assigned  them. 
Thus,  we  can  be  sure  that  no  sensible  person  would  contend 
that  the  people  of  the  United  States  could  afford  to  have  their 
chief  executive  live  on  $1,000  a  year  even  if  he  were  perfectly 
willing  to  do  so.  To  do  his  job  at  all  well,  he  must  spend,  on 
matters  more  or  less  personal  in  their  nature,  many  times  $1,000. 
What  is  true  of  the  president  of  a  great  republic  is  true  in 
only  lesser  degree  of  hundreds  of  other  men.  In  fact,  if  we 
sufficiently  narrow  the  circle  of  interested  persons,  it  is  true  in 
a  way  for  almost  every  male  citizen.  To  the  other  members 
of  his  family,  it  is  more  important  that  the  breadwinner,  though 
the  humblest  of  day-laborers,  should  be  well  fed  than  that  the 
rest  should  be,  because  only  so  can  he  be  fit  to  earn  the  income 
on  which  they  all  depend.  But,  of  course,  the  point  is  more 
forcefully  illustrated  in  the  greater  relations  of  society.  To 
those  men  whose  functions  involve  large  responsibilities, 
intense  miental  activity,  and  great  nerve  strain,  we  must, 
for  our  own  sakes,  give  large  incomes,  in  order  that  they  may 
prove  resolute,  clearsighted,  well-poised,  and  in  other  respects 
fitted  for  their  great  tasks.  To  this,  however,  the  objector  may 
say  that  we  really  have  here  a  case  not  of  better  income,  but 
rather  of  collateral  expenses.  Needs  such  as  these  should  be 
provided  for  as  part  of  the  outlay  of  the  office  which  the  man 
holds.  If  $1,000  is  the  best  income  the  community  can  afford 
its  members,  the  president,  as  a  man,  must  be  satisfied  with  that 
income ;  though  on  his  office  we  may  spend  $100,000.  Doubtless 

407 


PRINCIPLES  OF  ECONOMICS 

something,  perhaps  much,  could  be  done  along  this  line  ;* 
but  the  whole  difficulty  could  not  be  met  in  this  way.  The  need 
involved  is  often  so  personal,  individual,  in  character  that  it  can- 
not be  provided  for  save  through  a  fund  placed  at  the  disposal 
of  the  person  interested.  One  person  requires  one  sort  of  re- 
laxation, perhaps  a  very  inexpensive  one ;  another  requires  a 
very  different  sort,  perhaps  a  very  costly  one.  Further,  the 
employing  public  (under  socialism),  with  whom  opinion  is 
greatly  under  the  influence  of  persons  who  are  not  in  a  posi- 
tion to  judge  of  the  personal  needs  attaching  to  the  higher 
social  functions,  would  commonly  underrate  those  needs,  as  is 
shown  in  the  niggardly  salaries  now  paid  public  officials  in 
democracies.  In  consequence,  provision  for  this  kind  of  need, 
if  made  in  a  formal  sort  of  way,  would  probably  be  far  too 
small. 

(2)  The  preceding  paragraph  has  brought  out  one  reason 
why  inequality  of  income  is  necessary  in  the  interest  of  the  very 
persons  whose  apparent  incomes  would  be  raised  by  the  abolition 
of  that  inequality.  A  second  and  more  important  reason,  which  in  a 
way  belongs  to  the  same  class,  is  found  in  the  fact  that  unless 
incomes  are  unequal,  they  will  not  even  approximately  express 
the  relative  sacrifices  involved  in  contributing  different  services, 
and,  so,  will  cause  an  oversupply  of  services  which  involve  small 
sacrifices  and  an  undersupply  of  the  opposite  kinds.  This  diffi- 
culty has  always  been  recognized  by  the  creators  of  Utopias ;  and 
to  meet  it  a  considerable  variety  of  ingenious  schemes  have  been 
brought  forward.  Thus,  some  writers  have  proposed  that  con- 
scripts from  all  classes  should  have  to  serve  a  certain  length 
of  time  in  objectionable  trades.  Others  nave  reserved  these 
occupations  for  the  convicts.  More  recently,  we  have  had  much 
stress  laid  on  (a)  variations  in  the  length  of  the  labor  day  and 
(b)  honor  rewards.  An  undesirable  occupation  might  be  made 
attractive  by  reducing  the  day  from  6  hours  to  4,  or  3,  or  any 
figure  which  might  prove  necessary.  So,  attractiveness  mieht 
be  given  said  occupation  by  attaching  thereto  decorations,  official 
rank,  and  so  on.  Now,  it  seems  highly  improbable  that  these 
devices  should  have  anything  like  the  effectiveness  which  is 
anticipated  from  them.  The  honor  device,  especially,  overlooks 
the  fact  that  honors,  to  be  effective  as  a  stimulus  to  emulation, 

'Personally  I  heartily  believe  in  such  a  policy  wherever  possible. 
408 


CHAPTER  XIV.    CRITIQUE  OF  PRESENT  ORDER 

must  not  be  too  commonly  employed.  Gaining  a  prize  is  not 
worth  while,  if  almost  all  the  contestants  gain  prizes.  Being  a 
member  of  an  academy  which  every  one  can  join  by  paying  $5, 
will  attract  people  only  so  long  as  they  are  ignorant  of  the 
facts.  But,  whether  these  schemes  are  practicable  or  not,  there 
can  be  no  doubt  that  they  are  inconsistent  with  real  equality. 
Why  do  I  object  to  my  neighbor's  having  a  better  income  than 
I,  supposing  mine  to  be  enough  for  a  decent  life?  Obviously, 
it  is  because  the  spectacle  of  his  enjoying  advantages  which 
I  can  not  enjoy  detracts  from  my  peace  of  mind.  Novr,  what 
matter  as  to  the  source  of  these  advantages !  To  see  him 
watching  the  great  national  game,  or  comfortably  lying  in  the 
shade,  while  I  toil  and  sweat  in  the  sun  would  surely  awake 
in  me  an  unpleasant  sense  of  contrast  if  these  privileges  were 
granted  him  as  a  direct  reward  for  accepting  some  particular 
task  just  as  truly  as  they  now  give  me  such  an  experience 
when  they  come  as  an  indirect  reward  for  that  same  service.  So, 
again,  one  of  the  greatest  objections  to  the  inequality  of  the 
present  order  is  that  it  gives  to  the  men  of  larger  incomes  a 
higher  place  in  the  consideration  of  their  fellows,  better  social 
standing,  and  so  on.  Will  this  deeper  sort  of  inequality  be 
any  less  obnoxious  when  it  is  directly  created  than  when,  as 
at  present,  it  is  the  indirect  result  of  inequality  in  money  income? 
(3  We  have  brought  out  two  reasons  why  people  generally, 
considered  as  consumers,  must  in  their  own  interest  prefer 
that  there  should  be  inequality  of  incomes, — that  some  other 
persons  should  receive  better  incomes  than  themselves.  We 
have  reserved  for  the  last  the  weightiest  reason  of  all.  There 
must  be  inequality  of  incomes,  some  contributions  must  com- 
mand much  higher  prices  than  other  contributions,  because  only 
in  this  way  can  it  be  made  certain  that  society  will  make  the 
best  use  of  its  resources,  its  productive  capacities.  In  a  previous 
discussion.  Section  A,  Chapter  X,  it  was  shown  that,  in  a 
world  like  ours  in  which  different  kinds  of  ultimate  factors 
enter  in  different  proportions  into  the  production  of  different 
commodities,  said  different  kinds  of  ultimate  factors  being  lim- 
ited in  amount  and  capacity,  each  of  said  kinds  of  factors  will 
have  its  own.  special  significance  or  importance  as  determined 
by  the  part  it  plays  in  producing  goods.  In  the  same  connec- 
tion, it  was  also  explained  that,  under  the  present  system  of 
free  private  initiative  and  exchange,  the  assigning  to  each  factor 

409 


PRINCIPLES  OF  ECONOMICS 

a  price  which  expresses  approximately  its  true  significance  is 
accomplished  automatically.  Now,  we  hardly  need  say  that  by 
some  process  or  other  the  same  task  must  be  performed  under 
any  system  of  economic  organization,  e.g.,  socialism;  since, 
otherwise,  we  could  not  have  any  assurance  that  we  were  making 
the  best  use  of  our  capacities. 

In  the  first  place,  assigning  to  things  their  proper  price 
would  be  necessary  under  socialism  just  as  truly  as  at  present, 
as  a  part  of  the  public  system  of  bookkeeping.  For  it  is  hardly 
necessary  to  say  that,  if  the  state  were  to  become  the  sole 
landlord,  capitalist,  and  entrepreneur,  it  would  be  obliged  to 
carry  on  an  elaborate  and  complete  system  of  bookkeeping  in 
order  to  have  at  hand  the  knowledge  of  conditions  necessary  to 
a  reasonable  conduct  of  economic  affairs;  and,  in  this  book- 
keeping, the  state  would  need  to  credit  each  ultimate  factor 
with  the  true  significance  of  that  factor,  since,  otherwise,  it 
would  frequently  waste  important  factors  on  unimportant  com- 
modities. That  is,  whether  or  not  men  were  actually  to  receive 
unequal  incomes,  they  would  have  to  be  credited  with  unequal 
contributions. 

But,  it  having  been  admitted  that  the  books  of  the  socialist 
state  would  be  obliged  to  credit  each  person  with  the  true 
value  of  his  contribution,  can  it  be  doubted  that,  under  any 
system  which  is  in  the  remotest  degree  practicable,  said  value, 
or  something  approximating  it,  would  have  to  be  paid  to  the 
man  who  made  said  contribution?  We  say  "under  any  system 
which  is  in  the  remotest  degree  practicable ;"  for  one  might  admit 
that  a  despotically  organized  communism,  a  system  under  which 
the  effecting  and  regulating  of  cooperation  is  through  authority, 
could  "exploit  the  workers" — to  use  a  socialist  phrase, — i.  e., 
could  give  equal  remuneration  for  very  unequal  services.  But 
surely  we  do  not  need  to  take  communism  seriously.  We  need, 
therefore,  to  consider  only  the  case  of  socialism.  Could  that 
system  of  economic  organization  escape  paying  men  in  some 
proportion  to  their  contribution?  The  answer  is  surely  a  nega- 
tive one.  One  could,  indeed,  conceive  a  socialist  state  which  at 
first  thought  would  seem  able  to  avoid  the  necessity  of  adjusting 
reward  to  contribution; — I  mean  a  state  conterminous  with  the 
earth  and  organized  as  a  completely  centralized  despotism.  Such 
a  state  might  seem  to  be  emancipated  from  all  necessity  for 
paying  its  workers  according  to  any  standard  other  than  its 

410 


CHAPTER  XIV.    CRITIQUE  OF  PRESENT  ORDER 

own  sweet  will;  since  competition  would  have  been  completelv 
eliminated.*  But  it  is  surely  quite  unnecessary  to  take  seriously 
the  idea  of  a  cooperative  commonwealth  coextensive  with  the 
earth  and  organized  as  a  completely  centralized  despotism.  If 
we  ever  have  a  collectivist  state,  it  will  be  one  among  many 
sovereign  states  and  a  state  in  which  local  autonomy,  municipal 
and  provincial,  still  exists.  It  will,  therefore,  be  one  in  which 
competition  still  exists.  Different  municipalities,  different  com- 
monwealths, different  sovereign  states  will  more  or  less  vie 
with  each  other  in  trying  to  attain  the  highest  efficiency,  and  sc 
will  drive  one  another  into  paying  laborers  what  they  are  worth. 

As  a  general  result  of  this  long  discussion,  I  think  w^  may 
conclude  that  the  ideal  of  distribution  which  would  give  to 
each  citizen  an  equal  share  with  every  other  is  entirely  out  of 
the  question: — the  remuneration  received  by  each  must  bear 
some  sort  of  relation  to  his  contribution.  But,  in  insisting  upon 
this  point,  we  would  not  be  understood  as  claiming  that  inequal- 
ities must  always  be  just  as  great  as  they  are  today.  We  have 
no  doubt  that  they  would  be  much  reduced  under  a  socialist 
regime  and  that  they  will  be  much  reduced  under  the  present 
regime.  Our  present  task  is  merely  to  make  it  clear  that 
inequality  is  mevitable.f 

C.  We  have  discussed  the  Need  and  Equality  ideals  of 
distribution.  We  ought  perhaps  to  touch  briefly  another  ideal 
which  seems  to  have  been  more  or  less  consciously  held  by 
many  socialists  of  the  earlier  type.  Each  should  share  in  the 
joint  income  in  proportion  to  his  labor.  This  of  course  can  be 
differently  interpreted.  One  may  have  in  mind  the  sacrifice  made 
or  the  results  accomplished.  He  may  conceive  the  sacrifice  as 
measured  in  a  subjective  standard  or  an  objective  one  like  time. 
Tn  general,  the  socialists  seem  to  have  had  in  mind  primarily 
the  sacrifice  ideal,  measured  by  the  time  spent.  Yet  they  tried 
not  to  divorce  this  completely  from  results,  by  insisting  that 
the  labor  in  question  must  be  labor  which  produced  things,  and 
standardised  labor  at  that, — i.  e.,  labor  which  in  the  given  place 

*  This  hypothesis  is  of  course  too  fantastic  to  merit  serious  considera- 
tion. I  doubt  if  even  the  vast  despotism  supposed  would  be  able  to 
exploit  the  capable  in  any  such  way, — and  that  for  two  reasons:  (i)  the 
capable  would  probably  be  in  power,  and  (2)  if  not,  they  would  anyhow 
know  their  importance  and  by  a  single  refusal  to  work  for  less  could  compel 
the  authorities  to  raise  their  pay  till  it  equalled  the  value  of  their  contri- 
bution. 

f  If  the  object  were  of  sufficient  importance  one  might  easily  show 
that  inequality  has  considerable  compensations. 

411 


PRINCIPLES  OF  ECONOMICS 

and  time  was  "socially  necessary"  to  accomplish  the  result. 
Marx  made  a  further  concession  to  reality  by  admitting  that 
we  could  not  treat  all  kinds  of  labor  as  quite  the  same,  though 
he  would  not  admit  quantitative  differences.  The  labor  of  the 
artist  and  that  of  the  mechanic  must  be  treated  as  differing  in 
intensity,  or  density,  so  to  speak^  That  is,  one  hour  of  the 
artist's  labor  should  be  reckoned  as  the  equivalent  of,  say, 
three  of  the  mechanic's.  The  futility  of  all  this  is  easily  shown. 
Any  scheme  of  distribution  which  can  reasonably  ask  for  our 
verdict  must  in  serious  measure  make  economic  reward  condi- 
tioned upon  economic  significance, — differences  of  economic 
reward  correlative  to  differences  in  economic  significance.  This 
Marx  tacitly  admits  by  refusing  to  reward  labor  which  produces 
nothing  useful,  and  by  insisting  that  all  labor  must  be  stand- 
ardized, reduced  to  "socially  necessary  labor."  But  differences 
in  the  economic  significance  of  the  several  kinds  of  labor  often 
show  no  correspondence  either  to  labor  time  or  to  labor  intensity. 
Accordingly,  it  is  quite  out  of  the  question  that  labor  as  meas- 
ured in  labor  time,  even  when  corrected  for  intensity,  should  be 
accepted  as  the  principle  of  distribution. 

D.  There  is  one  other  conceivable  ideal  of  distribution  which 
is  probably  more  or  less  definitely  held  by  many  intelligent 
people,  let  us  call  it  the  Social  Service  ideal.  This  ideal  differs 
from  that  embodied  in  the  present  order  in  that,  under  the 
latter,  each  is  paid  the  price  which  expresses  the  significance 
of  his  services  to  individuals  graded  according  to  the  buying 
power  they  possess,  while,  under  the  social-service  principle, 
the  significance  of  a  man's  services  to  the  group  as  a  whole  or 
to  all  individuals  without  any  reference  to  their  wealth  or 
poverty,  would  be  the  criterion. 

This  ideal  of  distribution  has  no  doubt  a  very  plausible 
sound.  There  is  something  particularly  obnoxious  in  the  fact 
that,  under  the  present  system,  the  power  to  furnish  services 
of  a  very  trivial  sort,  or  even  services  highly  immoral  in  their 
character,  enables  the  owner  to  command  a  large  income,  be- 
cause persons  desiring  such  services  chance  to  possess  great 
buying  power.  But,  after  all,  there  is  nothing  in  this  proposal. 
First,  in  so  far  as  it  concerns  the  group  as  a  whole,  the  new 
principle  is  already  contained  in  the  old.  The  group  is  fully 
organized  and  through  the  use  of  the  sovereign  power  of  taxa- 
tion can  insure  that  group  wants  are  satisfied  at  whatever 

412 


CHAPTER  XIV.    CRITIQUE  OF  PRESENT  ORDER 

cost,  i.  e.,  can  see  that  services  to  the  group  are  paid  for  in 
accord  with  their  importance.  Secondly,  the  proposed  ideal  as 
applied  to  individuals,  is  self-contradictory: — a  principle  of 
distribution  simply  can  not  pay  according  to  the  importance  of 
the  service  rendered  and  not  pay  according  to  the  importance 
of  the  service  to  individuals  graded  according  to  buying  power. 
(1)  Since  men  are  to  be  paid  in  accord  with  services  rendered, 
they  are  to  be  paid  unequally.  (2)  This  obviously  means  that 
the  effective  demand  for  commodities  and  services  will  be  un- 
equally distributed.  (3)  But  the  distribution  of  effective  de- 
mand will  necessarily  determine  in  what  proportion  people  will, 
actually  consume  goods.  (4)  But  the  only  importance  which 
can  signify  anything  is  importance  to  actual  consumers.  (5) 
It  follows,  therefore,  that  to  pay  for  services  according  to  their 
importance  to  individuals  without  discrimination  as  to  wealth 
or  poverty,  is  to  pay  for  those  services  in  accord  with  their 
importance  to  persons  who  do  not  get  them  at  all, — a  process 
which  really  amounts  to  paying  for  services  without  regard  to 
their  importance. 

3.    Argument  for  the  Service-Value  Principle. 

That  the  service-value  principle  is  entirely  defensible,  in  fact 
is  the  only  defensible  one,  has  almost  necessarily  been  estab* 
lished  in  arguing  for  the  impossibility  of  the  equality  ideal. 
But  it  is  perhaps  best  to  give  a  formal  summary  of  the  case 
and  comment  on  two  or  three  objections. 

A.  The  ultimate  and  unassailable  justification  for  the 
Service-Value  Principle  is  necessity.  Under  no  other  principle 
could  the  economic  action  of  a  society  in  which  any  degree  of 
individual  liberty  or  local  self-government  was  retained,  be 
rightly  guided, — i.  e.,  guided  so  as  to  make  the  best  use  of  its 
capacities.  Theoretically,  perhaps,  a  despotic  state,  world-wide 
in  extent  and  completely  centralized  in  administration,  could 
come  somewhere  near  the  result  by  much  experimentation,  at 
the  cost  obviously  of  a  ruthless  exploitation  of  the  capable  in 
the  interest  of  their  fellows  and  of  society  in  general.  Even 
in  that  case,  however,  it  would  be  necessary  to  credit  each 
agent  in  production  with  the  whole  value  of  his  contribution. 
For  value,  price,  is  nothing  more  than  a  particular  method  of 
expressing  the  relative  importance  of  things.  Correct  prices, 
therefore,  are  necessary  if  we  are  to  be  furnished  with  correct 

413 


PRINCIPLES  OF  ECONOMICS 

estimates  of  this  relative  importance.  But,  further,  in  the  case 
of  elements  the  output  of  which  depends  on  human  consent,  it 
is  not  enough  that  we  have  correct  paper  prices, — bookkeeping 
prices, — we  must  also  have  correct  real,  objective,  prices,  i.  e., 
we  must  pay  correct  prices ;  for,  only  in  that  way,  can  we  insure 
the  forthcoming  of  the  several  elements  in  their  proper  propor- 
tion. If  socialism  ever  triumphs,  if  the  state  comes  to  under- 
take the  responsibility  of  production  as  the  sole  entrepreneur, 
it  will  find  itself  obliged  to  pay  its  employees  in  a  general 
accord  with  the  true  values  of  their  contributions.  It  might 
still  effect  a  vast  improvement  in  the  lot  of  the  majority  of 
men  by  eliminating  many  violations  of  the  service-value  prin- 
ciple which  corrupt  the  present  order,  by  exploiting  in  the 
interest  of  all  rather  than  of  the  few  the  great  natural  resources, 
by  abolishing  or  very  strictly  curtailing  inheritance,  even  by 
taxing  with  considerable  severity  the  incomes  of  those  who 
supply  specially  valuable  services.  But,  after  all,  the  socialist 
state  would  find  itself  obliged  to  adopt  as  its  guiding  principle 
the  same  old  rule  that  the  values  imputed  to  things  must  be 
a  true  expression  of  their  marginal  significance,  and  that  the 
prices  of  those  particular  things  which,  being  bought  on  the 
open  market,  have  prices  must  correctly  express  their  true 
value. 

B.  The  preceding  paragraph  has  brought  out  the  positive 
argument  on  which  is  based  a  final  verdict  in  favor  of  the 
Service-Value  principle.  Let  us  take  a  moment  to  comment  on 
one  or  two  objections. 

(a)  Probably  the  misgiving  which  most  persistently  recurs 
to  a  fair-minded  man  who  in  general  recognizes  the  full  weight 
of  the  argument  for  the  service-value  principle,  is  that  the 
whole  attitude  of  mind  in  which  such  a  principle  seems  plaus- 
ible to  us  is  somehow  too  cold-blooded,  too  insensible  to  consid- 
erations of  sympathy,  humanity,  love  of  one's  fellows.  When 
one  is  exercising  his  logical  faculties  on  mere  abstractions  or 
is  dealing  with  concrete  objects  which  are  mere  things,  e.  g., 
apples,  potatoes,  etc.,  it  sounds  all  right;  but  the  case  is  very 
different  when  the  interests  at  stake  are  the  incomes  and, 
therefore,  the  happiness  of  living  human  beings.  Is  there  not 
something  inherently  shocking  to  our  moral  sense,  even  to  our 
sense  of  mere  decency,  in  the  advocacy  or  adoption  of  a  prin- 
ciple which  places  interests  like  these  at  the  mercy  of  so  unmoral 

414 


CHAPTER  XIV.    CRITIQUE  OF  PRESENT  ORDER 

a  thing  as  the  law  of  supply  and  demand,  or  the  law  of  marginal 
utility?  Does  not  every  right-minded  man,  at  one  time  or 
another,  respond  with  full  approval  to  the  belief  expressed  by 
Mill  that  a  time  would  come  when  the  division  of  society's 
product,  instead  of  being  a  matter  of  automatic,  mechanical, 
regulation,  "would  be  made  by  concert  on  an  acknowledged 
principle  of  justice"?  In  fact,  is  not  this  whole  attitude  of 
mind  which  conceives  human  beings  as  functioning,  i.  e.,  as 
mere  instruments,  mere  things,  inherently  wrong?  Must  we  not 
rather  at  all  times  conceive  human  beings  as  ends  in  themselves, 
never  mere  things? 

Now  there  is  surely  some  force  in  all  this.  We  have  never 
denied  that  a  higher  principle  of  distribution  than  the  present 
one  is  possible.  We  merely  insist  that  this  is  the  only  practicable 
one.  We  believe  that  its  working  in  the  actual  order  can  be 
greatly  improved  by  changes  which  would  better  satisfy  the 
demands  of  moral  and  humanitarian  sentiment  above  alluded  to. 
We  believe  that  its  worst  tendencies  could  be,  and  are,  not  a 
little  offset  by  a  secondary  distribution  through  voluntary  benev- 
olence and  the  use  of  the  taxing  power, — all  this  in  obedience 
to  the  same  moral  and  humanitarian  sentiment.  But,  when  all 
is  said  and  done,  we  have  still  no  choice  but  to  submit  our- 
selves to  a  necessity  which,  if  somewhat  shocking  to  sentiment, 
is  after  all  very  real.  We  must  accept  the  domination  of  the 
service-value  principle,  because  it  is  the  only  principle  which 
can  sustain  society  from  falling  into  the  poverty  and  misery 
of  communism.  Nor,  in  truth,  is  the  domination  of  the 
service-value  principle  quite  the  dreadful  thing  it  is  pictured. 
The  correctness  of  the  humanitarian  sentiment  above  expressed 
is  not  quite  so  certain  as  is  often  assumed.  Not  a  few  people 
persist  in  believing  that  a  man  ought  to  be  paid  what  he  is 
worth.  A  still  larger  number  feel  no  response  to  the  notion 
that  it  is  wrong  ever  to  conceive  human  beings  as  functioning, 
as  in  some  relations  mere  instruments,  mere  things.  There  is 
nothing  unworthy  or  degrading  in  taking  one's  turn  at  being 
a  mere  thing,  a  something  which  functions  in  the  service  of 
others.  On  the  contrary,  most  men  who  have  passed  forty  have 
come  to  feel  that  there  is  little  else  that  is  worthy  or  satisfy- 
ing; and  they  have  on  their  side  the  opinion  of  the  greatest 
religious  teachers.  In  any  case,  whether  it  is  a  burden  c;  a 
privilege,  a  curse  or  a  blessing,  it  is  the  destiny  of  all.  From 

4T5 


PRINCIPLES  OF  ECONOMICS 


the  highest  to  the  lowest,  we  must  spend  a  considerable  fart 
of  our  lives  being  the  servants  of  others,  mere  instrumen:  to 
secure  their  welfare. 

(b)  Among  people  who  interest  themselves  in  our  problem 
but   have    little   or   no    economic   training,    there   appears    some 
disposition    to   criticise   the   ruling   principle   of    distribution   be- 
cause   it   pays    men    in   accord   with   what    we   might   call   their 
effective  utility  Bather  than  in  accord  with  their  absolute  utility. 
Thus,  the  utility  of  coal  miners  as  a  class  is  surely  far  greater 
than    that   of   high-grade    singers    as    a   class ;   but   society   pays 
a  miner   for  an   hour's   work,   perhaps,   40   cents,   while   it  pays 
the  singer  for  an  hour's  work,  perhaps,  $2,000.     This  objection 
always    arouses    a    sympathetic    response    in    the   popular    mind; 
but    to    the    student    who    has    acquired    any    comprehension    of 
economic   relations,    it   is   quite   without   point.     A   person   who 
puts  forward  this  objection  really  admits  by  implication  that  it 
is  right  to  have  men  paid  in  accord  with  the  importance  of  their 
services;    the    objector    only   complains    that   we    set   the   wrong 
standard  for  judging  importance.    The  answer  is  easy.    The  rea1 
importance   of   any   man  is   his    effective   importance, — what  we 
should  lose  if  w-e  lost  him,  not  what  we  should  lose  if  we  lost 
his  whole  class.     For  in  nearly  all  cases,  the  alternative   facing 
us    is,    not   keeping   or   losing   the   whole   class,   but   keeping   or 
losing  an  individual   of  the  class;  and  what  we  lose  by    losing 
any  individual  of  a  class  is  only  the  utility  of  the  least  useful 
of  the  class,  since  the  loss  of  any  higher  utility  would  be  avoided 
by  transferring  the  least  important  member  of  the  class   from 
his  present  task  to  the  higher  one. 

(c)  Another   objection    closely   allied   to   the   last   criticises 
the  Service-Value  principle  because  it  pays  a  man,  nor.  in  accord 
with  his  own  specific  utility,  but  in  accord  with  the  utility  of  the 
marginal  member  of  his  class.    Thus,  a  man  may  be  performing 
some  service   for  which  his  employer   is  glad  to  pay  him,   and 
does  pay  him,  $2  a  day;  when,  without  any  fault  on  the  work- 
man's part,  an  increased  supply  of  labor  comes  on  the  market 
and   lowers   the   marginal   utility   of    this   class    of   workmen   to 
$1.50    per    day,    with   the    final    result    that    the    first    workman, 
though    still    performing   the    $2    service,    now    gets    only   $1.50. 
This  objection  makes   less  appeal   to  one's  sympathies  than  the 
preceding   one;    since  it  could   easily  be   contended  that  to  pay 
one   man   $2    a    day,    when   another    working   just    as   hard   and 

416 


CHAPTER  XIV.    CRITIQUE  OF  PRESENT  ORDER 

perfectly  able  to  replace  the  first  was  getting  only  $1.50,  was 
doing  wrong  to  the  latter.  But,  whatever  the  merits  of  the 
sentimental  issues  involved,  this  objection,  like  its  predecessor, 
is  quite  untenable  logically.  If  a  man  is  to  be  paid  in  accord 
with  his  importance  at  all,  the  importance  in  question  must  be 
real,  effective  importance.  But  the  real  importance  of  a  man 
is  determined,  not  by  the  importance  of  the  particular  thing  he 
accomplishes,  but  by  the  importance  of  the  thing  which  the 
marginal  number  of  his  class  accomplishes. 

Section   D.    The   Legitimacy  of   Interest,   Profits,  and   Rent, 
Supposing  Them  to  be  Absorbed  by  the  State. 

In  the  preceding  section  we  have  contended  for  the  legiti- 
macy of  the  present  system  in  respect  to  the  general  principle 
of  distribution  which  it  is  supposed  to  embody : — Give  to  each 
person  an  income  which  expresses  the  marginal  significance  to 
his  fellows  of  his  type  of  service.  But,  as  has  been  repeatedly 
pointed  out,  this  leaves  much  of  our  task  unaccomplished.  The 
Service- Value  principle  may  be  all  right  in  general  but  quite 
wrong  when  applied  under  the  conditions  prevailing  in  the 
present  order.  Thus,  in  the  present  order  private  persons  are 
permitted  to  own  land  and  capital,  and,  so,  the  services  oi 
land  and  capital  are  reckoned  as  the  services  of  said  private 
persons,  with  the  final  result  that,  under  the  working  of  the 
service-value  principle,  said  private  persons  receive  interest, 
profits,  and  rent.  Is  the  service-value  principle,  when  so  applied, 
legitimate?  In  other  words:  Are  interest,  profits,  and  rent, 
as  sources  of  private  income,  legitimate?  In  answering  this 
question,  we  begin  with  a  preliminary  question.  Are  interest, 
profits,  and  rent  legitimate,  supposing  them  to  be  absorbed  by 
the  state?  To  this  we  will  devote  the  present  section. 

1      The  Legitimacy  of  Interest,  Supposing  the  State  to  be  the 

Sole  Capitalist. 

In  an  earlier  connection,  we  discussed  the  various  manifesta- 
tions of  the  interest  phenomenon  which  are  found  in  the  exist- 
ing order.  Of  these  manifestations,  we  found  two  general 
classes:  explicit  and  implicit  interest.  Under  thoroughgoing 
socialism,  explicit  interest — interest  on  contractual  loans — could 
e>-ist,  if  at  all,  only  on  the  smallest  scale;  since,  with  the  state 
occupying  the  position  of  sole  entrepreneur  as  well  as  that  of 

417 


PRINCIPLES  OF  ECONOMICS 

sole  capitalist,  productive  borrowing  would  be  excluded,  while, 
on  the  other  hand,  consumptive  borrowing  from  the  state  would 
be  consciously  restricted  within  very  narrow  limits.  Accord- 
ingly, interest,  if  appearing  on  any  considerable  scale  in  the 
thoroughly  socialist  state,  would  be  of  the  implicit  type;  that  is, 
it  would  show  in  the  prices  of  goods, — meaning  both  the  prices 
quoted  on  the  market  in  the  case  of  goods  which  were  sold 
fo  private  persons,  and  the  prices  recorded  on  the  books  of  the 
srovernment  in  all  cases.  We  will  begin  with  the  second  case, 
i.  e.,  the  prices  recorded  on  the  government's  books. 

\s  has  already  been  pointed  out  and  as  must  be  evident 
4o  every  one,  if  government  is  to  perform  the  stupendous  task 
of  conducting  all  industrial  activity  with  any  sort  of  success, 
it  must  keep  a  complete,  detailed,  and  trustworthy  set  of 
nrcounts — a  set  of  accounts  which  represents  the  true  values  of 
both  immediate  and  ultimate  goods; — since,  without  such  ac- 
counts, said  government  could  never  be  sure  that  it  was  con- 
ducting its  vast  interests  in  such  a  way  as  to  make  the  best 
use  of  the  resources  at  its  command.  In  short,  the  government 
of  a  socialist  state  will  need  just  as  elaborate  and  complete 
a  system  of  values,  prices,  as  that  existing  today.  But,  while 
a  complete  system  of  values  will  be  necessary,  it  is  of  course 
possible  that  the  values  will  in  many  cases  be  somewhat  different 
from  those  of  an  individualist  regime.  Nay  more,  it  is  possible 
that  some  cases  of  value  may  disappear  altogether.  A  thing 
or  a  condition  comes  to  have  value  only  when  two  conditions 
at  least  are  fulfilled:  (1)  its  disposal  must  involve  some  advan- 
tage, and  (2)  there  must  be  some  limitation  on  its  being  sup- 
plied, whether  absolute  or  conditional  (cost).  Now  it  is  conceiv- 
able that,  under  socialism,  one  or  the  other  of  these  conditions 
will  be  lacking  in  cases  where  both  are  present  under  the  exist- 
ing regime.  Thus,  the  advantage  derived  from  a  service  today 
may  be  of  such  a  nature  that  it  will  disappear  when  socialism 
is  established,  e.  g.,  the  services  of  an  office  furnishing  abstracts 
of  titles.  On  the  other  hand*,  the  effective  limitation  of  supply 
now  existing  may  be  due  to  the  arbitrary  action  of  a  monopolist 
and  so  bound  to  disappear  under  socialism.  Are  either  of  these 
possible  in  the  case  of  interest?  Would  the  advantage  or  advan- 
tages for  which  interest  is  paid  disappear  under  socialism? 
Would  the  supply  of  the  condition  which  furnishes  that  advan- 
tage prove  so  abundant  that  it  would  no  longer  have  marginal 

418 


CHAPTER  XIV.    CRITIQUE  OF  PRESENT  ORDER 

utility  and  therefore  no  longer  have  value?     A  negative  answer 
is  inevitable  in  both  cases. 

First,  the  advantage  or  advantages  for  which  interest  is  paid 
would  not  disappear  under  socialism.  As  was  brought  out  in 
Section  G,  Chapter  XIII,  the  essential  nature  of  the  transaction 
through  which  interest  arises  is  the  exchanging  of  future  for 
present  goods.  That  is,  interest  is  usually  a  price  paid  for  the 
privilege  of  having  goods  now,  though  we  do  not  pay  for  them 
till  later.  Now,  this  privilege  carries  with  it  different  advantages 
under  different  circumstances.  Of  these,  the  greatest  and  most 
important  is  commonly  expressed  by  saying  that  capital  is 
productive.  By  getting  control  of  a  fund  of  wealth  now  while 
freed  from  the  necessity  of  paying  for  it  till  later,  we  are 
enabled  to  choose  the  more  efficient  methods  of  production 
which  require  longer  periods  of  time.  A  lesser  advantage  flowing 
from  the  privilege  of  exchanging  future  for  present  goods  is 
that  it  enables  us  to  substitute  payment  at  a  more  favorable, 
for  payment  at  a  less  favorable,  time.  Thus,  a  man  starting  in 
on  a  job  has  perhaps  no  surplus  in  his  purse;  a  month  later 
he  will  have  seventy-five  dollars ;  the  exchange  which  enables 
him  to  bring  into  the  present  the  better  provision  of  the 
future  has  surely  given  him  an  advantage.  Now,  would  these 
advantages  continue  to  exist  under  socialism?  Surely,  yes.  It 
may  oe  that  the  second  advantage  will  cease  to  be  effectual 
"because  the  socialist  state  refuses  to  make  advances  to  imprudent 
or  unfortunate  citizens  who  wish  to  anticipate  the  provision  of 
the  future ;  but  the  need  will  certainly  exist  and  so  the  possible 
advantage.  As  respects  the  supreme  advantage  derived  from 
the  possession  of  capital, — being  able  to  choose  more  efficient 
methods  of  production — this  certainly  could  not  disappear  save 
on  the  hypothesis  that  the  whole  order  of  physical  relations  wai 
overturned  and  a  new  one  established  in  which  direct,  immediate, 
methods  were  more  efficient  than  roundabout,  time-consuming 
methods.  Of  course  no  one  anticipates  any  such  revolution  in  the 
natural  order  of  the  physical  universe,  as  a  result  of  the 
establishment  of  socialism.  Under  that  system,  it  would  stili 
be  necessary  to  make  tools  before  we  made  tables.  The  powei 
to  wait,  the  being  so  situated  that  we  could  devote  wealth 
or  productive  power  which  might  be  employed  for  present  needs 
to  providing  for  future  needs, — this  would  be  just  as  necessary 
under  socialism  as  under  the  present  order.  It  is  certain,  then, 

419 


PRINCIPLES  OF  ECONOMICS 

that  the  privilege  of  exchanging  future  against  present  wealth 
would  be  of  advantage  to  the  governmental  entrepreneur  of  the 
socialist  system  just  as  it  is  to  the  individualist  entrepreneur 
of  our  system. 

But,  in  the  second  place,  is  it  at  all  likely  that  the  other 
condition  which  is  necessary  to  give  presentness  a  value,  viz., 
that  it  should  be  relatively  scarce,  will  disappear  under  social- 
ism? In  support  of  an  affirmative  answer,  some  one  might  say 
that  the  scarcity  existing  at  present  is  artificial,  and  so  would 
disappear  when  the  only  capitalist  is  the  state,  the  sovereign. 
But  this  is  manifestly  unsound.  There  is  scarcely  any  other 
part  of  the  economic  structure  in  which  competition  is  so 
free  as  in  the  market  for  capital.  An  artificially  controlled 
supply  is  quite  out  of  the  question.  If  the  scarcity  now  existing 
is  to  disappear  under  socialism,  this  will  have  to  be  for  some 
other  reason  Can  it  be  that  capital  will  increase  far  more 
rapidly  under  socialism  than  it  does  at  present?  Surely  the 
contrary  is  to  be  anticipated.  The  absence  of  excessively  large 
incomes  will  cut  off  one  great  source  of  capital;  another  will 
go  with  the  removal  of  the  necessity  for  saving  on  the  part  of 
the  masses  under  a  regime  which  assures  every  one  a  liveli- 
hood ;  finally,  the  direct  turning  back  of  income  into  business 
on  which  socialism  must  almost  entirely  rely,  will  be  much 
more  difficult  when  all  authority  is  in  the  hands  of  a  democracy, 
eager  lor  the  present  and  reckless  of  the  future. 

It  hardly  seems  necessary  to  carry  this  discussion  further. 
We  surely  can  not  doubt  that  under  socialism  the  right  to 
dispose  of  present  goods  while  paying  for  them  in  the  future 
would  have  a  marginal  utility  and  would,  therefore,  have  value. 
The  socialist  state  would  have  to  treat  the  future  uses  of  a 
piece  of  land  as  worth  less  than  its  present  use,  and,  so,  would 
have  to  make  the  sum  of  these  uses — the  value  of  the  land — 
a  good  deal  less  than  one  use  multiplied  by  infinity .  Again, 
the  socialist  state  would  have  to  treat  goods  which  cost  $200 
worth  of  past  labor  and  $100  worth  of  current  labor  as  more 
valuable  than  goods  which  cost  $300  worth  of  current  labor. 
And  so,  in  every  relation  where  implicit  interest  appears  under 
the  present  regime,  it  would  appear  in  the  socialist  bookkeeping. 

The  preceding  discussion  has  shown  that  implicit  inteiest 
would  have  to  appear  all  through  the  bookkeeping  of  the  social- 
ist government.  We  have  still  to  answer  the  question  whether 

420 


CHAPTER  XIV.    CRITIQUE  OF  PRESENT  ORDER 

it  would  be  present  in  the  prices  of  goods  sold  on  the  market. 
For  example,  would  the  state  find  itself  practically  obliged  to 
charge  more  for  goods  the  production  of  which  involved  the 
use  of  large  quantities  of  fixed  capital  than  for  goods  which 
were  almost  entirely  produced  by  current  labor.  Doubtless 
another  policy  could  be  conceived.  While  keeping  its  books 
soundly,  the  state  might  decide  to  sell  some  goods  below  cost — 
cost  being  interpreted  so  as  to  include  waiting,  interest  on 
capital.  But  it  could  not  pursue  such,  a  policy  without  unequal 
and  unjust  treatment  of  its  citizens.  For  there  can  be  little 
doubt  that  in  most  cases  there  would  appear  great  differences 
among  citizens  in  respect  to  the  amounts  they  would  consume 
of  these  products  which  involve  a  large  interest  element.  On 
the  other  hand,  the  burden  of  accumulating  capital  by  turning 
the  capacities  of  the  community  into  the  producing  of  future 
goods — goods  dependent  on  time-consuming  processes — would 
fall  on  people  generally.  The  only  way  to  insure  fair  play, 
then,  would  be  to  raise  the  prices  of  such  products  till  those 
prices  were  high  enough  to  put  the  burden  of  producing  said 
products  entirely  on  those  persons  who  consumed  them.  Ac- 
cordingly, we  conclude  that  interest  in  itself  is  a  legitimate 
element  in  price, — that,  supposing  such  interest  to  be  absorbed 
by  the  state  as  the  sole  capitalist,  it  is  an  entirely  legitimate 
share  in  distribution. 

2.     The   Legitimacy  of    Profits,    Supposing  the   State  to  be   the 

Sole  Entrepreneur. 

Of  all  the  regular  economic  incomes,  profits  would  probably 
show  greatest  modification  under  a  socialist  regime.  Yet  even 
profits  would  doubtless  appear  in  somewhat  disguised  form,  and, 
hence,  must  be  reckoned  as  a  perfectly  natural  and  legitimate 
source  of  income  under  the  proper  conditions.  In  support  of 
this  contention,  little  more  need  be  said  than  to  remind  the 
reader  of  the  points  previously  made  with  respect  to  this 
particular  source  of  income.  Profits,  as  popularly  interpreted, 
commonly  include  three  elements:  wages,  interest,  and  profits 
proper.  The  wages  element  would  of  course  persist  under 
socialism.  So  also  would  the  interest  constituent,  as  we  have 
just  seen.  What,  then,  as  to  pure  profits, — the  excess  over 
ordinary  interest  received  by  the  entrepreneur  who  turns  over 
managerial  functions  to  others?  That  excess,  we  have  argued, 

421 


PRINCIPLES  OF  ECONOMICS 

owes  its  origin  to  the  burdens  which  are  involved  in  taking  the 
final  responsibility  of  production.  Of  these  burdens,  the  chief 
is  the  fear  of  loss,  though,  under  the  existing  order,  other 
psychological  elements  are  doubtless  present.  Now,  it  seems 
quite  certain  that,  under  a  socialist  regime,  this  burden  would 
be  altered  fundamentally  in  character,  as  also  somewhat  dimin- 
ished in  amount;  but  it  would  not  be  eliminated.  At  present 
the  burden  takes  the  form  of  a  risk  of  never-to-be-compensated 
loss ;  and  profits  constitute  the  prize  necessary  to  induce  men 
to  overcome  their  natural  indisposition  to  assume  such  a  risk. 
But,  under  a  system  which  concentrated  all  resources  in  the 
hands  of  a  single  owner,  all  risks  would  be  pooled,  and,  there- 
fore, would  almost  disappear  as  risks,  being  replaced  by  the 
certainty  of  fairly  regular  losses.  In  other  words,  the  socialist 
state  would  be  obliged  every  year  to  write  off  a  considerable 
volume  of  losses.*  That  is,  some  of  its  expenditure  would 
have  gone  for  naught.  To  make  its  books  balance,  this  excess 
of  expenditure  would  have  to  be  charged  against  all,  or  some 
portion,  of  the  products  which  resulted  wherever  industry  was 
successful.  Naturally  the  products  chosen  would  be  those  of 
the  industries  where  the  losses  had  occurred.  In  no  other  way 
could  we  avoid  burdening  other  citizens  in  the  exclusive  interest 
of  those  who  consumed  the  products  of  riskful  industries.  We 
conclude,  accordingly,  that  profits  constitute  a  legitimate,  even 
necessary,  element  in  an  economic  system, — being  inevitable 
even  in  a  socialist  state.t 

3.     The    Legitimacy    of    Rent,    Supposing    the    State    to    be    the 

Sole   Landlord. 

Here  an  extended  discussion  is  even  less  called  for  than 
under  Profits.  Rent  inevitably  emerges  as  the  result  of  any 
process  of  natural  value  determination.  It  could  not  help  existing 
under  socialism.  As  soon  as  the  best  land,  cultivated  to  the  point 
of  diminishing  returns,  proves  unable  to  supply  as  much  product 
as  is  demanded  at  some  price  above  cost  of  production,  price 
rises  and  in  so  doing  creates  a  surplus  over  cost  which 

*As    also    to    credit    itself    with    some    unexpected    gains. 

•f  It  would  be  easy  to  argue  that  in  many  cases  the  burden  of  profits 
Mpon  consumers  would  be  greater  in  the  socialist  state  than  it  is  today, 
in  that  today  private  entrepreneurs  gamble,  so  to  speak,  on  the 
chance  of  loss  or  gain,  whereas  the  socialist  state  would  reduce  the 
whole  matter  to  a  question  of  arithmetic,  and,  having  ascertained  the 
precise  loss,  would  distribute  it  upon  the  product  pro  rata. 

422 


CHAPTER  XIV.    CRITIQUE  OF  PRESENT  ORDER 

under  any  regime  is  bound  to  be  credited  to  the  given  piece 
of  land.  Being  so  credited,  the  land  takes  on  value  as  the 
source  of  said  surplus.  If  the  surplus  is  large,  the  value  is 
large.  All  this  is  inevitable  under  any  rational  system.  The 
socialist  state  probably  could  not  get  rid  of  it  by  any  action 
however  arbitrary.  This  would  apply,  not  merely  to  the  book- 
keeping of  the  state,  but  also  to  the  system  of  market  prices. 
For  surely  the  socialist  state  could  not  have  different  prices 
for  the  same  product  in  the  same  time  and  place,  and  it  could 
not  fix  as  the  one  price  anything  under  the  marginal  cost  of 
production ;  since,  in  so  doing,  it  would  discriminate  in  favor 
of  the  consumers  of  the  particular  commodity  in  question  as 
against  the  rest  of  its  citizens.  But,  if  the  state  leaves  prices 
to  be  fixed  at  marginal  cost,  it  thereby  permits  rent  to  exist. 

Section  E.    The  General  Legitimacy  of  Interest,  Profits,  and 
Rent  as  Sources  of  Private  Income. 

In  the  preceding  section,  we  argued  for  the  legitimacy  of 
interest,  profits,  and  rent,  supposing  the  state  to  be  the  sole 
capitalist,  entrepreneur,  and  landlord.  That  is,  we  argued  that 
these  shares  correspond  each  to  some  portion  of  the  output, 
which  portion,  on  any  rational  system  of  valuation,  is  to  be 
imputed  or  credited  to  the  productive  factor  involved.  They 
would,  therefore,  exist,  and  ought  to  exist,  if  the  present 
economic  system  were  replaced  by  the  cooperative  common- 
wealth.— only  in  that  case  they  would  fall  to  the  state  and  so 
would  benefit  all  rather  than  the  few.  There  still  remains  to  be 
considered  the  question  whether  interest,  profits,  and  rent  are 
legitimate  as  private  shares, — sources  of  private  income.  This 
question,  however,  really  contains  two  questions:  (1)  Whether, 
abstractly  speaking, — viewed  broadly — the  shares  named  are 
legitimate  sources  of  private  income,  and  (2)  whether,  under 
the  conditions  actually  prevailing,  with  all  the  weaknesses  of 
human  nature,  these  shares  are  legitimate.  It  is  the  first  of 
these  questions  which  we  here  consider. 

1.     The  Legitimacy  of   Private   Interest,   Abstractly  Considered. 

Those  who  affirm  that  there  is   something  essentially  wrong 

in  permitting  private  persons  to  receive  interest  must  maintain 

either  (1)   that  it  is  essentially  v^rong  to  permit  private  persons 

423 


PRINCIPLES  OF  ECONOMICS 

to  own  capital,  or  (2)  that,  though  right  to  permit  private  per- 
sons to  own  capital,  it  is  essentially  wrong  to  permit  them  to 
receive  a  net  income  from  that  capital.  Now  the  first  of  these 
alternatives  surely  need  not  delay  us  long.  As  against  com- 
munism, indeed,  a  defense  of  the  right  even  to  own  capital 
without  deriving  any  income  therefrom,  would  be  necessary; 
since  communism  holds  that  r.-j  right  of  property  is  legitimate. 
But  today  communists  are  almost  unknown.  It  is  only  with 
socialists  that  we  have  to  reckon;  and  socialists  are  constantly 
admitting  both  directly  and  indirectly  that  there  is  nothing 
inherently  wrong  in  the  private  ownership  of  capital.  Thus, 
they  hold  that  it  was  right  for  private  persons  to  own  capital 
so  long  as  the  persons  who  did  the  owning  were  the  laborers 
who  used  the  capital  for  productive  purposes.  Further,  they 
expect  that  under  socialism  individuals  will  be  permitted  to 
accumulate  surpluses  of  general  wealth,  which  today  constitute 
the  original  form  of  all  .-dpital.  Again,  they  constantly  admit 
that,  if  the  capitalist  of  t^day  would  be  content  to  receive  back 
what  he  puts  into  indust ,'/,  relinquishing  the  surplus,  no  wrong 
would  be  involved 

But,  even  if  the  socialist  should  affirm  that  the  private  own- 
ing of  capital  is  inherently  wrong,  he  would  find  few  to  agree 
with  him.  The  case  is  too  evident,  according  to  his  own  funda- 
mental ethical  principle.  For  the  fundamental  ethical  principle 
of  socialism  is  that  each  has  a  valid  title  to  what  he  produces; 
and,  though  men  doubtless  become  owners  of  capital  through 
fraud,  corrupt  practices,  gift,  inheritance,  and  other  methods 
which  can  not  be  described  as  producing  said  capital,  yet  it  is 
equally  certain  that  they  may  become,  and  do  become,  owners 
of  capital  by  producing  it;  so  that,  on  the  very  principles  of 
socialism,  they  have  a  right  to  own  said  capital. 

We  come  then  to  the  second  of  the  only  two  alternatives 
which  are  open  to  the  man  who  affirms  that  the  taking.  01 
interest  by  private  persons  is  essentially  wrong ; — it  is  essentially 
wrong-  to  permit  the  owners  of  capital  to  receive  a  net  income 
from  that  capital.  Now,  this  position,  again,  is  quite  untenable 
on  the  fundamental  principle  of  socialism.  In  the  first  place, 
the  capitalist  who  really  produces  the  capital  which  he  is  per- 
mitted to  own  is,  to  some  degree  anyhow,  a  producer  of  the 
product  which  emerges  when  his  capital  is  productively  employed. 
This  follows  from  the  socialist  doctrine  that  the  man  who  pro- 

424 


CHAPTER  XIV.    CRITIQUE  OF  PRESENT  ORDER 

duccs  the  capital  produces  the  goods  which  the  capital  produces.* 
But,  secondly,  since  the  capitalist  who  has  really  produced  his 
capital  is,  to  some  extent  anyhow,  a  producer  of  the  product 
which  emerges  when  his  capital  is  employed,  it  follows  that  he 
has  a  valid  claim  to  some  portion  of  said  product;  since  produc- 
ing a  thing  is,  on  socialist  principles,  precisely  the  ground  on 
which  a  valid  title  to  that  thing  is  based.  In  the  third  place,  the 
capitalist  not  only  has  a  valid  claim  on  some  portion  of  the 
product  emerging  from  the  employment  of  his  capital,  he  has 
such  a  claim  on  all  that  portion  which  can  properly  be  credited 
to  himself,  that  is,  all  which  through  his  capital  'he  has  produced ; 
for  producing  a  commodity  not  only  creates  a  valid  title  to  that 
commodity,  it  is  also  the  only  thing  which  does  so, — that  is,  the 
producer  has  a  valid  claim  on  his  whole  product.  It  follows  from 
all  this  that  the  socialist  assumption  that  the  'honest  capitalist  has 
a  right  to  just  so  much  of  his  product  as  will  replace  his  capital, — 
no  less  and  no  more — is  not  at  all  what  he  seems  to  think  it,  i.e.  an 
aximomatic  truth  needing  no  demonstration.  What  the  capitalist 
really  has  a  right  to,  on  socialist  principles,  is  what  he  produces 
through  his  capital.  If  this  is  less  than  the  amount  needed  to 
replace  said  capital,  he  has  a  right  to  less  than  enough  to  replace 
his  capital;  if  it  is  more  than  enough,  he  has  a  right  to  more  than 
enough.  Accordingly,  the  re,al  crux  of  the  matter  is  whether  the 
capitalist  produces  through  'his  capital  more  than  enough  to 
replace  it.  Has  capital  net  productivity?  We  will,  therefore,  once 
more  run  over  the  argument  on  this  point. 

The  general  question  whether  or  not  capital  yields  a  net 
product  could  conceivably  be  tested  in  either  of  two  ways.  First, 
in  a  very  simple  economic  society,  it  is  usually  possible  to  com- 
pare capitalistic  and  non-capitalistic  methods  with  respect  to  their 
physical  or  technical  productivity.  That  is,  we  can  compare  the 
result  obtained  from  a  certain  amount  of  labor  spent  getting 
product  directly  with  the  result  obtained  from  an  equal  amount 
of  laibor  spent  getting  product  by  the  roundabout  or  capitalistic 
method.  In  such  a  condition  of  things,  therefore,  we  could  decide 
whether  or  not  as  a  mere  technical  fact,  the  second  or  capitalistic 
method  of  using  our  labor  gave  just  the  same  product  ,as  that 
labor  would  have  given  if  used  the  other  way,  or  more,  or  less. 
Further,  this  would  seem  to  mean  that  we  'should  be  able  to 
decide  whether  capital  just  replaced  itself,  or  gave  more  or  less. 
But,  now,  admitting  that  this  first  test  would  be.  adequate  for 

425 


PRINCIPLES  OF  ECONOMICS 

primitive  conditions,  this  is  certainly  not  true  under  a  developed 
economic  order.  In  the  latter  case,  this  test  could  be  utilized 
only  in  the  rarest  cases,  and  this  for  two  reasons.  First,  speak- 
ing generally,  the  same  kind  of  labor  could  not  be  employed 
indifferently  (i)  in  producing  a  certain  commodity  without 
capital,  (2)  in  making  capital,  and  (3)  in  using  capital.  Men  do 
not,  could  not,  shift  from  one  kind  of  these  productive  activities 
to  another.  In  consequence,  a  direct  comparison  of  the  two  plans 
of  procedure,  in  respect  to  the  labor  expended,  is  out  of  the 
question.  Secondly,  the  cooperative  character  of  most  productive 
processes  in  the  present  order  often  makes  it  impossible  to  dis- 
tinguish a  technical  product  for  each  of  the  different  factors 
involved,  in  other  words,  compels  us  to  be  satisfied  with  trying 
to  ascertain  the  significance  or  importance  of  each  factor. 

We  have  seen  that  our  first  test  as  to  the  net  productivity  of 
capital,  even  if  it  would  be  really  adequate,  cannot  be  utilized, 
generally  speaking,  tinder  the  present  economic  order.  We  are 
driven,  then,  to  resort  to  a  second  test,  namely,  the  presence  or 
absence  of  an  index  of  productivity  in  money  values.  We  com- 
pare the  money  value  of  the  cost  goods  utilized  in  production  and 
the  money  value  of  the  product,  as  these  money  values  are  de- 
termined under  free  competition;  and,  if  a  surplus  is  disclosed, 
we  say  that  capital  has  net  or  surplus  productivity.  Manifestly, 
it  is  possible  to  apply  this  test.  But  is  it  a  valid  test?  Is  the 
existence  of  a  value  surplus  an  unfailing  index  of  the  existence 
of  a  product  or  utility  surplus?  I  hardly  need  say  that,  if  we 
accept  the  doctrine  taught  in  Chapter  10  that  prices  necessarily 
tend  to  express  marginal  significances  or  utilities,  we  must  answer 
the  above  question  in  the  affirmative.  Assuming  competition 
among  capitalists,  the  existence  of  a  surplus  value  in  product 
over  costs  other  than  waiting  power  proves  that  capital  is  econ- 
omically responsible  for  a  surplus  product,  that  is,  a  product  in 
excess  of  the  amount  necessary  to  replace  itself.  The  argument 
for  this  contention  has  already  been  fully  covered  in  Chapter  10. 
I  will  add1  here  only  this  much  :  if  the  natural  working  of  the 
laws  of  price  cannot  be  trusted  to  define  the  real  share  of 
capital — waiting  power — in  production,  the  proposition  assumed 
by  the  socialists  that  capital  so  far  produces  as  to  replace  itself, 
has  no  more  warrant  than  our  contention  that  it  produces  more 
than  enough  to  replace  itself.  For,  if  money  values  do  not  supply 
a  trustworthy  index  of  contribution,  if  the  quantity  of  product 

426 


CHAPTER  XIV.    CRITIQUE  OF  PRESENT  ORDER. 

which  is  credited  to  capital  through  money  values  may  be  too 
large  'by  the  amount  of  the  surplus,  it  may  be  too  large  by  twice  or 
thrice  this  much.  That  is,  we  have  no  method  whatever  of  prov- 
ing that  capital  produces  enough  to  replace  itself  any  more  than 
we  have  of  proving  that  it  produces  enough  to  replace  itself  and 
pay  6%  also.  In  fact,  we  can  go  still  further,  ,and  say  that,  if 
the  money  values  which  emerge  under  free  competition  cannot 
be  accepted  as  trustworthy  indices  of  contribution  to  product,  we 
cannot  be  sure  but  that  capital  produces  not  merely  a  beggarly 
6%  surplus;  it  may  in  fact  produce  a  surplus  large  enough  to 
cover  the  whole  product. 

Thus  we  see  that  it  is  not  possible  to  maintain  either  (1).  that 
it  is  essentially  wrong  for  private  persons  to  own  capital,  or 
(2)  that  it  is  essentially  wrong  for  them  to  receive  a  net  income 
from  capital.  There  is,  therefore,  nothing  essentially  wrong  or 
illegitimate  in  private  interest. 

2.  The  Legitimacy  of  Private  Profits 

There  are  no  doubt  many  cases  of  profits  which  it  would  be 
difficult  to  defend.  But  profits  in  general,  a  return  to  the  per- 
son who  assumes  the  responsibility  of  cooperative  production, 
this  is  too  plainly  reasonable  to  merit  serious  discussion.  That 
such  persons  are  producers  in  the  sense  that  they  supply  a  con- 
dition essential  to  the  result  is  obvious.  That  they  are  pro- 
ducers in  the  sense  that  to  them  some  portion  of  the  joint  prod- 
uct is  actually  imputed  is  sufficiently  proved  by  the  fact  that 
they  get  profits.  (Compare  the  case  of  interest  above.)  But,  if 
profits  roughly  correspond  to  a  product  of  the  entrepreneur,  they 
surely  can  not  be  condemned  as  inherently  wicked.* 

3.  The  Marxian  Theory  of  Profits  and  Interest. 
A  natural  addendum  to  the  above  argument  that  private  in- 
terest and  profits  are  not  inherently  unreasonable  or  illegitimate, 
is  the  refutation  of  the  most  important  among  the  theories 
which  support  the  opposite  conclusion.  It  is  not  too  much  to 
say  that  the  socialist  propaganda  of  today  derives  its  chief 
power  from  a  particular  theory  of  profits  and,  through  that,  from 
a  particular  theory  of  value  on  which  said  theory  of  profits  is 

*It     is     interesting     to     note  that     even      Medieval     theologians,      who 

sweepingly    condemned    all    forms  of    interest-taking,    permitted    the    taking 

of  profits  by  those  who  accepted  the  full  responsibilities  and  risks  of  an 
enterprise. 

427 


PRINCIPLES  OF  ECONOMICS 

based.  In  an  earlier  connection,  we  discussed  that  theory  of 
value — the  Labor  theory.  Here  we  have  to  comment  upon  the 
theory  of  profits  which  was  built  upon  that  theory  of  value  and 
which  has  been,  and  continues  to  be,  one  of  the  most  powerful 
weapons  of  socialism  in  its  attack  upon  the  present  order.  The 
theory  in  question  is  commonly  known  as  the  Surplus-Value 
theory  or  the  Exploitation  theory.  Besides  the  standard  form, 
it  appears  in  one  or  two  popular  guises  which  probably  have 
more  influence  than  the  original  theory. 

A.    The  Standard  Form  of  the  Surplus-Value  Theory. 

In  oredr  to  insure  something  like  an  exact  understanding  of 
the  surplus-value  theory,  I  will  put  the  statement  of  it  into  a 
Series  of  four  formal  propositions,  as  follows:  (1)  The  value 
of  the  output  of  any  producing  unit  (factory,  railway,  etc.)  is 
determined  by  the  labor  expended  upon  that  output.  (2)  The 
value,  or  cost  to  the  employer,  of  labor  power  (capacity  to  give 
off  labor  services)  is  determined  by  the  labor  necessary  to  keep 
up  the  supply  of  such  labor  power,  to  produce  the  living  of  labor- 
ers. (3)  The  labor  power  purchased  by  the  employer  is  able  to 
give  off  considerably  more  labor  than  the  amount  necessary  to 
produce  the  living  of  the  laborer;  and  the  employer  sees  to  it 
that  the  labor  power  he  buys  does  give  off  this  excess  of  labor. 
(4)  Accordingly,  the  value  of  the  employer's  output  is  in  excess 
of  his  outlay;  and,  so,  he  gets  a  surplus  which  he  divides  with 
landlords  and  capitalists 

To  make  this  more  definite,  let  us  work  out  a  concrete  illus- 
tration. Let  us  suppose  that  it  costs  the  labor  of  one-half  day 
to  produce  the  goods  commonly  considered  necessary  to  support 
a  laborer  and  his  family  for  one  day,  which  goods,  according 
to  the  cost  theory  of  wages,  must  constitute  the  price  of  a  day  of 
labor  power,  i.e.,  wages.  Let  us  suppose,  again,  that  to  produce 
25.8  grains  of  gold  also  costs  one  half-day  of  labor,  and  that 
the  law  decrees  that  25.8  grains  of  gold  shall  constitute  one 
dollar.  Under  these  conditions,  the  price  of  one  day  of  labor 
power,  i.e.,  a  day's  wages,  will  be  $1.  At  the  same  time,  since 
the  labor  of  a  whole  day  will  produce  twice  25.8  grains  of  gold, 
every  day  of  labor  spent  on  any  product  will  put  into  that  product 
$2  of  value.  If,  now,  some  entrepreneur  buys  a  day  of  labor 
power  and  gets  out  of  it  a  day's  labor  in  spinning  raw  cotton 
which  has  cost  him  50  cents,  into  cotton  yarn,  that  yarn  will  be 
worth  $2.50;  i.e.,  50  cents  due  to  the  cost  of  the  raw  cotton  and 


CHAPTER  XIV.    CRITIQUE  OF  PRESENT  ORDER. 

$2  because  of  the  day's  work  put  into  it.*  But  the  labor  power 
which  gave  the  employer  a  full  day's  labor  and,  so,  put  $2  of 
value  into  the  yarn,  actually  cost  him  only  $1.  Accordingly,  he 
finds  himself  in  possession  of  a  surplus  of  $1.  This  dollar  is 
his  profits. 

There  are  various  criticisms  which  might  be  passed  on  the 
surplus-value  theory;  but  its  prime  defect  is  its  dependence  on 
the  erroneous  doctrine  that  value  is  determined  by  labor  only. 
It  attempts  to  explain  the  difference  between  the  value  of  the 
product  and  the  labor  power  for  which  the  entrepreneur  must 
pay — which  difference  constitutes  profits — as  due  to  the  fact  that 
the  labor  necessary  to  produce  the  entrepreneur's  product  is 
greater  than  that  necessary  to  produce  the  required  labor  power. 
But,  as  we  learned  in  Section  B,  Chapter  X.,  the  labor  theory 
of  value  is  quite  untenable.  Consequently,  if  there  is  a  reg- 
larly  recurring  difference  between  the  outlay  of  the  entre- 
preneur and  the  value  of  his  product, — and  of  course  there  must 
be  to  give  profits — that  difference  must  have  some  other  ex- 
planation. What  it  is,  has  been  brought  out  again  and  again. 
The  entrepreneur,  in  supplying  capital  (his  own  or  that  of  some 
one  else)  and  in  undertaking  the  responsibility  of  production, 
has  contributed  elements  essential  to  the  result,  and  as  these 
elements  are  not  yet  supplied  in  amounts  equal  to  the  need  for 
them,  some  portion  of  the  output  is  credited  to  them,  and,  so, 
something  less  than  the  whole  output  is  credited  to  the  labor 
required.  In  consequence,  the  entrepreneur,  who  will  surely  be 
driven  by  competition  to  pay  for  labor  substantially  the  whole 
of  that  portion  of  the  output  which  is  imputable  to  it,  will  not, 
after  all,  be  required  to  pay  labor  the  whole  of  that  output. 

B.  In  the  preceding  discussion,  we  have  presented  what  has 
been  called  the  standard  form  of  the  surplus-labor  theory. 
Alongside  of  this  standard  form  appear  one  or  two  interpre- 
tations which  are  probably  more  potent  in  creating  sentiment 
against  the  present  order  than  is  the  orthodox  one.  The  most 
important  of  these  might  be  described  as  the  Capital-Monopoly 
theory.  While  not  usually  presented  in  formal  fashion,  jt  is 
constantly  appearing  in  socialist  writings,  even  in  those  of  Marx. 
It  runs  in  this  wise.  In  our  day,  the  great  development  of 
capitalistic  methods  of  production  has  made  it  impossible  for 

*For  the  sake  of  simplicity  I  have  ignored  wear  and  tear  of  ma- 
chinery and  other  minor  expenses. 

429 


PRINCIPLES  OF  ECONOMICS 

workingmen  to  o'-^ii  the  instruments  necessary  to  utilize  their 
labor  power,  so  that  these  have  necessarily  become  the  property 
of  other  persons.  But  laborers  can  not  get  along  without  these 
instruments,  and  are,  therefore,  compelled  to  accept  such  terms 
of  employment  as  the  owners  of  those  instruments  dictate, 
relinquishing  a  large  portion  of  what  they  produce  as  the  price 
of  having  the  opportunity  to  produce  at  all.  Now  this  method 
of  presenting  the  case  is  potent  as  a  means  of  propaganda,  and 
it  has  a  plausible  sound;  but  it  will  not  bear  the  least  analysis. 
No  class  of  productive  agents  can  dictate  their  own  terms,  unless 
they  are  organized  as  a  monopoly.  But  manifestly  this  not  the 
case  with  capitalists, — entrepreneurs.  On  the  contrary,  com- 
petition is  very  full  and  free.  So  long  as  this  continues  to  be 
true,  labor  will  tend  to  get  all  that  portion  of  the  joint  output 
which  is  imputable  to  it  as  its  product. 

4.     The  Legitimacy  of  Private  Rent. 

Among  the  several  private  shares  into  which  the  social 
income  is  divided,  rent  has  always  been  the  one  vritb  respect  to 
to  the  legitimacy  of  which  there  has  been  the  most  serious 
doubt.  This  does  not  mean  that  there  has  been  serious  question 
as  to  the  propriety  or  necessity  of  there  being  such  a  share 
as  rent,  but  only  as  to  the  propriety  of  its  going  to  the  persons 
who  now  receive  it.  For  the  position  which  economists  have 
only  recently  come  to  take  with  respect  to  interest,  viz.,  that  it 
is  a  natural  and  inevitable  element  in  any  economic  order,  was 
quite  early  taken  with  respect  to  rent.  We  can  shift  the  land- 
ing place  of  rent,  but  we  can  not  destroy  it.  Rent,  as  an  ad- 
vantage derived  from  land  and  enjoyed  by  some  person  or  per- 
sons to  the  exclusion  of  other  persons,  save  in  so  far  as  it  is 
arbitrarily  redistributed, — rent  in  this  sense  can  not  help  existing. 
Again,  the  doubt  as  to  the  propriety  of  the  present  destination 
of  rent  does  not  involve  any  doubt  as  to  the  productivity  of  the 
land  on  which  rent  is  received.  There  can  be  no  question  that 
a  portion  of  the  product  obtained  from  an  industrial  combination 
which  utilizes  a  rent-bearing  piece  of  land  must  be  credited  to 
said  piece  as  its  special  product,  on  any  rational  system  of  eco- 
nomic bookkeeping.  It  follows,  then,  that,  if  any  man  or  body 
of  men  has  a  valid  right  to  own  the  land,  such  man  or  body  of 
men  has  the  right  to  receive  the  rent  of  that  land  as  being  the 
product  of  said  land.  Accordingly,  the  crux  of  the  whole  mat- 

'430 


CHAPTER  XIV.     CRITIQUE  OF  PRESENT  ORDER. 

ter  is  this:    Can  private  persons  acquire  a  valid  title  to  land? 

In  answering  the  above  question  in  the  affirmative,  we  admit 
at  once  that  it  is  more  difficult  to  justify  private  ownership 
in  the  case  of  land  than  in  that  of  capital.  The  fact  that  land 
is  not,  to  any  considerable  degree,  a  produced  good  in  the  ordi- 
nary acceptation  of  terms,  shuts  us  out  in  the  first  instance  from 
appealing  to  the  common  ethical  doctrine  that  a  man  has  a  valid 
title  to  what  he  produces.*  Doubtless  special  cases  arise  in  which 
the  common  moral  sentiment  would  recognize  some  service  of 
discovery  and  appropriation  as  sufficiently  fulfilling  the  requi- 
site of  productive  action  to  create  a  title  under  the  ordinary 
principle.  But  such  cases  are  infrequent.  Broadly  speaking,  land 
is  not  a  result  of  economic  production.  If,  then,  a  valid  title  can 
be  derived  only  from  production,  there  can  be  no  valid  title  to 
land  either  for  the  individual  or  for  the  state.  But  it  is  hardly 
necessary  to  say  that  production  is  not  the  only  adequate  basis 
of  a  valid  title.  If  it  were',  economic  cooperation  through  ex- 
change, would  obviously  be  impossible :  no  man  could  devote 
himself  to  producing  one  thing,  depending  on  exchange  with 
other  persons  to,  supply  him  with  other  things.  At  present, 
such  a  procedure  is  possible,  because  everybody  recognizes  that, 
in  so  far  as  the  validity  of  a  man's  title  to  property  rests  en  his 
own  action,  exchange,  carried  out  in  good  faith,  gives  just  as 
valid  a  title  as  does  production.^  The  farmer  who  trades  seven 
cords  of  woods  which  he  has  produced  for  a  cutter  has -now  just 
as  good  a  title  to  the  cutter  as  he  did  have  to  the  wood;  and, 
if  he  should  now  trade  the  cutter  for  a  double  harness,  he 
would -have  just  as  good  a  title  to  the  harness  as  he  did  have  to 
the  wood.  But  it  is  hardly  necessary  to  remark  that,  in  com- 
munities which  are  two  or  three  generations  old  and  in  which 
there  is  free  trade  in  land,  practically  all  the  landholders  have 
acquired  their  landed  properties  through  exchange.  It  follows, 
therefore,  that  they  have,  generally  speaking,  quite  as  good  titles 

*In  utilizing  as  an  ethical  basis  for  our  discussion  the  common 
doctrine  that  production  gives  a  valid  claim  to  goods,  I  do  not  wish 
to  be  understood  as  holding  either  (1)  that  said  doctrine  is  unquali- 
fiedly true,  or  (2)  that  there  is  no  other  valid  basis  for  a  property 
right  in  things.  On  the  contrary,  I  hold  that  law  can  rightfully,  main- 
tain any  system  of  property  rights  which  is  found  most  conducive  to 
the  welfare  of  society.  It  seems  best,  however,  in  meeting  popular 
objections  to  the  existing  order,  to  argue,  in  so  far  as  this  is  possible, 
•on  the  basis  of  such  fundamental  principles  as  are  accepted  by  people 
generally. 

•(•  In  so  far,  remember,  as  the  goodness  of  his  title  depends  on  him- 
self. 

431 


PRINCIPLES  OF  ECONOMICS 

to  those  properties  as  they  do  to  the  horses,  furniture,  carriages, 
etc.,  which  they  have  obtained  through  exchange. 

Note:  In  the  statement  that  exchange  gives  just  as  valid  a 
title  as  does  production,  appeared  the  qualifying  phrase:  "in 
so  far  as  the  validity  of  a  man's  title  to  property  rests  on  his 
own  action."  This  was  necessary  to  anticipate  the  objection 
which  some  would  urge  that  exchange  can  not  give  a  valid  title 
to  anything  unless  the  seller  himself  has  one  and,  besides,  has 
the  right  to  transfer  his  title.  Applying  this  consideration  to 
the  case  before  us,  they  would  say  (1)  that  ordinarily  the  actual 
private  owners  of  land  have  purchased  from  'other  private 
owners,  and  we  can  not  assume  that  the  titles  of  these  previous 
owners  are  valid,  since  this  would  beg  the  whole  question  of 
the  validity  of  private  titles  to  land;  and  (2)  that,  if  we  try 
to  meet  this  difficulty  by  harking  back  to  grants  by  the  state — 
the  only  natural  or  artificial  person  who  can  claim  a  valid  title, — 
we  have  to  assume  that  said  state  has  a  right  to  relinquish  its 
title,  to  alienate  its  property, — an  assumption  which  they  insist  is 
quite  unwarranted,  in  that  the  state's  title  is  that  of  a  trustee 
acting  for  society  as  a  whole  or  for  men  generally. 

It  is  obvious  that  the  pith  of  this  objection  is  contained  in 
the  second  part;  for,  if  the  original  title  derived  from  the  state 
were  good,  the  number  of  subsequent  exchanges  whether  one 
or  one  hundred  would  have  no  bearing  on  the  matter.  The 
decisive  question,  then,  is  this  :  Is  it  reasonable  to  claim  with 
the  followers  of  Henry  George  that  the  state  could  never  right- 
fully alienate  its  property  in  land  ?  Surely  in  this  age  there  can 
be  but  one  answer.  The  state  as  the  final  authority  can  do 
whatever  it  believes  to  be  for  the  highest  welfare  of  society; 
that  is,  it  has  the  right  to  alienate  its  property  in  land  when 
this  seems  to  be  the  right  course,  and  it  has  equally  the  right 
to  resume  such  property  when  that  course  comes  to  be  recog- 
nized as  the  right  one.  In  a  word,  the  social  welfare,  as  inter- 
preted by  the  highest  human  authority — the  state,  is  the  supreme 
law,  the  supreme  right.  If  a  man  has  done  his  part  toward 
gaining  a  valid  title  to  land  through  exchange,  he  need  not  give 
himself  anxiety  lest  the  original  grant  of  the  state  was  invalid. 

In  the  preceding  discussion,  we  defended  the  general  validitv 
of  private  titles  to  land,  and,  so  of  private  rent,  on  the  groimtf 
that  private  landowners  have  gained  their  titles  through  **x- 
change,  purchase.  Now,  the  same  facts  can  be  interpreted  in  a 
different  way,  and,  when  so  interpreted,  furnish  an  even  better 
defense  of  private  rent.  When  a  man  uses  $2,000  to  buy  a  piece 
of  ground  yielding  a  net  income  of  $100,  he  in  effect  transforms 
that  land  into  capital  and  its  income  into  interest.  Now,  I  do 
not  admit  that  he  literally  makes  capital  ot  the  land  or  interest 
of  the  rent.  The  land  is  still  a  different  thing  from  typical 

43-2 


•    CHAPTER  XIV.    CRITIQUE  OF  PRESENT  ORDER. 

capital;  and,  in  some  very  important  relations,  will  continue  to 
behave  differently  and,  therefore,  will  need  to  be  recognised  as 
different.  But,  for  our  present  needs,  land  in  effect  becomes 
capital.  For  our  present  needs,  the  real  problem  is  this : 
What  is  the  nature  and  origin  of  the  $100  income  derived  from 
the  given  piece  of  land, — said  income  being  looked  at  from  the 
standpoint  of  the  man  who  buys  the  land  in  order  to  get  said 
income.  To  this  question,  there  is  but  one  answer:  from  the 
standpoint  named,  this  income  is  interest.  If  there  were  no 
such  thing  as  interest,  i.e.,  if  the  rate  were  zero,  this  income, 
as  a  net  incomej  would  not  exist.  It  is,  indeed,  true  that  the 
$100  would  still  be  received  by  th<?,  landowner  each  year;  but, 
then  what  would  that  mean  as  compared  with  what  actually  hao- 
pens  now?  Under  the  present  system,  he  gets  $100  each  year  for 
an  indefinitely  extended  series  of  years;  but,  instead  of  having 
been  obliged  to  pay  for  each  of  these  $ioos  an  exactly  equal 
times  $100,  he  actually  had  to  pay  for  it  only  twenty  times  $100, 
i.e.,  $2,000.  If,  however,  there  were  no  such  thing  as  interest, 
though  he  would  still  get  the  $100  each  year,  he  would  have 
been  obliged  to  pay  for  each  of  these  $100's  an  exactly  equal 
amount,  that  is,  he  would  have  been  obliged  to  pay  for  the 
right  to  receive  $100  every  year  for  fifty  years,  fifty  times  $100, 
i.e.,  $5,000;  or,  for  that  right  covering  100  years,  one  hundred 
times  $100,  i.e.,  $10,000;  or,  for  that  right  covering  200  years, 
two  hundred  times  $100,  i.e.,  $20,000;  or,  for  that  right  covering 
an  indefinite  period  of  years,  an  indefinite  numbei  of  times  $100. 
In  short,  he  would  get  no  clear  income  from  the  land,  but,  in- 
stead, would  get  back  in  an  indefinite  series  of  annual  instal- 
ments, exactly  what  he  had  put  into  the  land  in  one  lump  sum. 

The  preceding  discussion  shows  that,  from  the  standpoint  of 
a  landowner  who  has  bought  the  land,  the  rent  of  said  land  is  in 
effect  interest.  It  follows,  then,  that,  if  interest,  as  a  type  of 
income  going  to  private  persons,  is  legitimate,  rent  is  also. 

But  there  is  still  one  more  objection  to  be  met.  The  critic  of 
the  present  order  may  observe  that,  though,  in  the  course  of 
the  transaction  by  which  land  changes  ownership,  rent  is  trans- 
formed into  interest,  yet  this  is  only  a  temporary  phenomenon. 
That  transformation  was  effected  because  the  v&lut  of  the  land 
adjusted  itself  to  an  income  determined,  not  by  the  natural  laws 
which  got'ern  interest,  but  by  those  which  govern  rent.  This 
process  of  adjustment  for  the  moment  established  a  ratio  be- 

433 


PRINCIPLES  OF  ECONOMICS 

tween  land  value  and  land  income  exactly  the  same  as  that 
which  prevails  between  capital  value  and  capital  income.  But, 
then,  this  did  not  really  make  rent  into  interest,  nor  bring  it 
under  the  dominion  of  the  natural  laws  which  govern  interest. 
The  very  next  day,  something  might  happen  to  double,  let 
us  say,  the  income  from  the  site,  therefore  to  double  its  value, 
and,  so  to  give  to  the  owner  of  the  land  an  income  and  a 
property  to  which  he  could  lay  no  valid  claim,  whether  we 
base  such  claims  on  production  or  exchange. 

Now,  the  above  objection  to  the  legitimacy  of  private  rent 
sounds  plausible;  but  it  is  not,  after  all,  difficult  to  answer. 
Just  as  an  unchanging  rent  derived  from  a  purchased  piece 
of  land  is  in  effect  interest,  so  an  increase  in  rent  derived 
from  such  a  piece  of  land  is  in  effect  profits.  Nay  more,  it  is 
profits.  For,  in  accepting  the  responsibility  of  owning  said 
piece  of  land,  a  man  exposes  himself  to  that  risk  which  ac- 
companies all  ownership,  i.e.,  the  risk  of  seeing  his  property 
fall  off  in  income  and  so  in  value.  To  induce  men  to  assume 
•said  risk,  it  is  necessary  that  there  should  also  be  present  the 
chance  of  unexpected  increase  in  income  and  value.  When 
•that  unexpected  increase  comes,  no  new  designation  is  needed 
•for  it;  it  is  simply  a  case  of  profits.  If,  therefore,  profits  in 
general  constitute  a  legitimate  source  of  income  for  private 
persons,  there  is  nothing  inherently  wrong  in  the  so-called 
unearned  increment  of  rents  and  land  values. 

Caution:  It  is  not  intended,  in  the  above  presentation  of 
this  matter,  to  leave  the  impression  that  the  legitimacy  of  private 
ownership  in  the  case  of  land  is  as  clear  and  certain  as  in 
some  other  cases.  Wherever  the  element  of  chance,  accident. 
plays  a  very  great  role,  there  is  much  to  be  said  in  favor  of 
public  ownership.  While  speculation  performs  a  real  economic 
function,  as  was  brought  out  in  an  earlier  connection,  such 
speculation  is  in  many  respects  hurtful  and  demoralizing.  A 
socialist  state  would  need  it  much  less  than  does  the  present 
order,  in  that  the  pooling  of  all  industries  would  greatly  di- 
minish the  risk  element.  Even  going  no  further  than  to 
'.assume  the  control  of  land  would  do  much  to  diminish  risk  and 
its  attendant,  evils.  .  But,  whether  private  or  public  ownership 
will  in  the  end  prpve  best,  of  this  there  can  be  no  doubt, 
'there  is  'nothing  inherently  wrong  in  the  private  ownership  of 
'land  and  the  private  receiving  of  rent. 

434 


CHAPTER  XIV.    CRITIQUE  OE  PRESENT  ORDER. 

Section  F.     Further  Questions  Involved  in  Determining  the 
Legitimacy  of  the  Present  System  of  Distribution. 

In  the  preceding  three  sections,  we  have  considered  the 
legitimacy  of  the  present  system  of  distribution  in  respect  to 
its  main  features :  the  principle  which  it  attempts  to  realize — 
the  service-value  principle — and  its  interpretation  of  that  prin- 
ciple so  as  to  give  interest,  profits,  and  rent  to  private  persons. 
Time  limits  compel  us  to  bring  this  discussion  to  a  close  with- 
out considering  various  other  questions  which  would  need  to  be 
answered  in  a  truly  complete  critique  of  the  existing  order.  We 
will,  however,  take  a  moment  to  call  the  student's  attention  to 
those  questions  without  undertaking  to  answer  them. 

1.  In    Section    E,    we    merely    attempted    to    argue    for    the 
general,    abstract,    legitimacy    of    interest,    profits,    and    rent    as 
private  shares,  though  admitting  that,  even  if  that  question  were 
answered  in  the  affirmative,  there  would  still  remain  the  ques- 
tion whether   under  the  conditions   actually  prevailing,   with   all 
the  known  weaknesses  of  human  nature,  the  shares  named  can 
legitimately  go  to  private  persons.     We  recognize  this  question 
to  be  a  really  serious  one.     We  see  much  force  in  the  conten- 
tion  that,   however   reasonable   it   may  be   on   general   principles 
to   permit   the   private   ownership    of   capital   and    land   and    the 
private  undertaking  of  industry,  the  evils  which  inevitably  result 
from  such  a  policy  in  the  actual   working  of  things  make  its 
continuance  impossible  of  justification.    But,  although  admitting 
the    force    of    this    consideration,    still,    in    view    of    the    great 
superiority,   in   other  respects,   of   private,   to   public,   ownership, 
and  in  view   of  the   fact  that  its   worst  evils  can   be   gradually 
removed   without   overturning   the   system,    we   believe   that  the 
system  of  private  ownership  should  be  maintained.   At  the  same 
time,  however,   we   believe   that   regulation   of   private   initiative 
should  be  carried  much  further  than  it  has  been,  that  the  lim- 
itations of  the  property  right  should  be  increased,  and  that  at  sy^. 
some   points,  how  many  and   what  only   experience  will   show, 
public  ownership  and  initiative  should  be  substituted  for  private. 

2.  A   second   supplemental  question   of   much   importance   is 
whether    the    present    system    is    justified    in    permitting    private 
individuals    to    acquire    possessions    through    inheritance    or    be- 
quest.    Personally,  I  am  disposed  to  answer  this  question  in  the 
affirmative  but  only  with  very  emphatic  qualifications.     I  would 
greatly    reduce    these    rights    both    directly    by    legislation ^  and 

435 


PRINCIPLES  OF  ECONOMICS 

indirectly  by  a  taxation  which  for  the  excess  of  larger   estates 
over  a  certain  minimum  would  amount  to  practical  confiscation. 

3.  Still    another    question    which    a    fuller    treatment    would 
attempt  to  answer  is  as  to.  whether  law   should  permit  private 
persons    to    enjoy    the    extraordinary    profits    which    flow    from 
the    exploitation    of    natural    resources,    public    franchises,    con- 
solidations, etc.    It  seems  very  doubtful;  but  the  question  is  too 
large  for  a  paragraph. 

4.  Finally,  one  of  the  most  important  questions  which  must 
be    left    unanswered    is    this :    How    far    can    society    afford    ta 
modify  the  primary  distribution  of  property  and  income  through 
a    secondary    distribution    effected    by    taxation?     For    it   would 
seem  plain  that,   if  the   dominance   of  the  present  principle   of 
distribution — to  each  in  accord  with  the  value  of  his  services — 
is  necessary  to  insure  the  proper   conduct  of   economic  affairs, 
we    should    spoil    everything    by    arbitrarily    contravening    the 
working  of   that   principle,   even    though   we   do   this  after  dis- 
tribution  in   accord  ivith   the   principle   has   once    been    effected. 
For  what  interest  would  a   man   have   in   earning  ten   times   as 
much   as   his    fellows,  if   he   is  to  be  reduced   to  their   level   by 
taxation?    Doubtless,  if  it  were  to  go  so  far  as  this,  he  would 
have  no  interest  in  seeking  the  better  income.     But,  on  the  other 
hand,  there    can  be  no  doubt  that  a  tax  much  heavier    than  that 
levied  on  his  poorer  neighbor  would  not  influence  in  any  material 
degree   his  economic  efficiency.     The   whole  problem   is   one   of 
degrees.    Probably  its  solution  is  possible   only  through  experi- 
ment.    In  any  case  we   shall  have  to  be  satisfied  with  merely 
suggesting  it. 

Section  G.    The  Efficiency  of  the  Regulative  Mechanism  Supplied 
by  the  Laws  of  Price. 

From  the  very  outset  of  our  study  of  economic  phenomena 
we  'have  tried  to  make  clear  that  we  are  dealing  with  a  great 
coordinated  totality  which  we  frequently  call  the  economic  or- 
ganism, and  that  this  great  totality  is  spontaneously,  automatical- 
ly, organized  and  regulated.  Further  it  was  made  clear  that  the 
regulative  mechanism  consists  o=f  exchange  with  its  system  of 
natural  laws.  Throughout  the  preceding  discussions  of  this 
chapter,  we  have  by  implication  touched  more  or  less  upon  the 
question  whether  these  regulative  natural  laws  work  well  or  HL 

436 


CHAPTER  XIV.    CRITIQUE  OF  PRESENT  ORDER. 

But  it  would  seem  desirable  to  treat  the  matter  more  systemat- 
ically, passing  in  review  the  several  principles  of  value  and  ask- 
ing how  far  each  is  naturally  fitted  to  perform  the  function  w'hich 
belongs  to  it  as  a  part  of  the  regulative  machinery.  Up  to  date, 
however,  it  has  been  impossible  to  carry  out  this  plan.  We  will, 
therefore,  content  ourselves  with  presenting  a  series  of  problems 
intended  to  bring  out  the  function  or  functions  which  may  seem 
to  be  assignable  to  eadh  principle,  and  asking  the  student,  to  point 
out  how  far  said  principle  seems  fitted  to  attain  a  reasonable  and 
desirable  result  in  the  performance  of  those  functions. 

ILLUSTRATIVE  PROBLEMS. 

1 

"Assuming  that  the  system  of  distribution  is  the  proper  one, 
the  Law  of  Single  Price  forms  in  general  a  reasonable,  de- 
sirable element  in  the  regulative  mechanism  of  economic  so- 
ciety." 

(a)  Explain  what  is  meant  by  the  part  of  the  above  sentence 
which  is  included  between  the  word  "forms"  and  the  end. 

(b)  Argue   in    favor   of   the   proposition. 

(c)  Suggest  cases  in  which  you  think  society  ought  to  inter- 
fere with  the  natural  working  of  the  Law  of  Single  Price. 

2 

"Assuming  that  it  is  reasonable  and  desirable  that  the  prices 
of  the  ultimate  cost  goods  should  be  such  as  to  express  their 
marginal  significance,  the  law  that  the  price  of  any  producible 
tends  to  equal  the  cost  of  producing  it  forms,  in  general,  a  rea- 
sonable element  in  the  regulative  mechanism  of  economic  so- 
ciety." 

(a)  Argue   in    favor   of   the   above   statement. 

(b)  Suggest  some  exceptions. 

(c)  Accepting    the    doctrine    of    the    quotation    what    would, 
generally  speaking,  be  the  proper  attitude  of  government  toward 
monopoly? 

3 

"Assuming  the  general  legitimacy  of  profits,  we  need  have 
no  fear  that  excessive  profits  will  appear  in  any  business  where 
competition  is  free." 

Argue  for  the  reasonableness  of  this  view. 

4 

"Assuming  that  the  system  of  distribution  is  the  right  one. 
in  view  of  all  the  facts,  prices  for  consumption  goods  which 
express  the  marginal  utility  of  the  ultimate  cost-goods  are  rea- 
sonable prices ;  for  such  prices,  and  those  only,  will  insure  that 
our  stock  of  productive  capacity  is  used  in  such  a  way  as  to 
correspond  most  nearly  with  demand." 

437 


PRINCIPLES  OF  ECONOMICS 

(a)  What   is   meant  by  the   phrase   "prices   for  consumption 
goods  which  express  the  marginal  utility  of   the  ultimate  cost- 
goods?" 

(b)  Argue    in    support    of    the    doctrine    contained    in    the 
quotation. 

5 

Why  is  the  present  economic  order  likely  to  do  better  than 
Socialism  in  respect  to  the  building  of  capital? 

6 

On  page  404  (lines  7-10)  appear  an  objection  to  the  principle 
given  on  p.  242,  when  considered  as  a  factor  in  the  regu- 
lation of  consumption. 

(a)  Give  several  illustrations  of  that  objection. 

(b)  (Argue    for   the    contention    that   these    cases    are    excep- 
tional. 

(c)  Assuming   that   provision   should   be    made  to  neutralize 
the  bad  working  of  automatic  regulation  in  these  cases  in  what 
different  ways  might  it  be  done? 

1 

"Let  us  suppose  that,  in  our  belief,  the  services  of  a  certain 
person,  let  us  call  him  Mr.  A.,  are  worth  to  the  rest  of  us  more 
than,  say,  ten  thousand  dollars  a  year;  that  we  can  get  those 
services  only  for  this  price;  and  that  we  decide  to  give  him 
said  price  though  each  of  the  rest  of  us  gets  only  an  income 
of  one  thousand  dollars  a  year.  By  virtue  of  the  fact  that  we 
so  decide,  we  also  decide  that  it  is  for  our  interest  that  the 
desires  of  Mr.  A  should  count  ten  times  as  strongly  as  those 
of  each  one  of  us,  in  determining  the  direction  which  productive 
activity  should  take.  In  other  words  we  decide  to  recognize 
that  that  quantity  of  Mr.  A's  wants  which  he  estimates  at  ten 
thousand  dollars  is  ten  times  as  important  as  the  quantity  of 
our  wants  which  we  estimate  at  one  thousand  dollars." 

(a)  Defend    and    illustrate    this   statement. 

(b)  Show  that  this  inequality  of  income  would   enable   Mr. 
A   to  deprive  you  or   me  of   the  satisfaction   of   some  want  in 
order  to  secure  the  satisfaction  of  some  want  of  his,  though,  if 
the  two  wants  were  compared  absolutely — by  some  outside  per- 
son— ,it  would  at  once  be  admitted  that  your  want  or  mine  had 
the  greater  absolute  magnitude. 

(c)  Under  the  hypothesis  made  in  the  quotation,  is  the  par- 
ticular result  noted  under    (b)    unreasonable?    Explain.     [Show 
that,  if  we  are  trying  to  ascertain   relative  importance,  we  are 
not  comparing  the  right  things  under  (b).] 

(d)  Do   you    suppose    that    Mr.   A,    or   anybody    else,    would 
consider  it  proper  or  decent  to  insist  on  the  rigid  carrying  out 
of  this  principle  in  every  case? 

(e)  Suppose   that,   of  the   two  wants   contrasted  under    (b), 
Mr.   A's  was   a  want   for  some  very  silly  pleasure,  would   this 
necessarily   make  your   answer  to    (c)    different?     Explain. 

(f)  Suppose  that  a  certain  Mr.  B  who  assists  Mr.  A  in  grati- 

438 


CHAPTER  XIV.    CRITIQUE  OF  PRESENT  ORDER. 

lying  the  very  silly  want  which  figures  in  (e)  gets  for  this  ser- 
vice to  Mr.  A  an  income  of  three  thousand  dollars  a  year,  and 
is,  therefore,  able  to  exert  three  times  as  much  influence  on  the 
direction  of  productive  activities  as  you  or  I.  Would  this  result 
be,  abstractly  speaking,  unreasonable?  Explain. 

(g)  Suppose  that  a  certain  Mr.  C  who  assists  Mr.  B  in 
gratifying  a  very  silly  want  of  the  latter  gets  for  his  services 
a  salary  of  two  thousand  dollars,  and,  therefore,  is  able  to  exert 
twice  as  much  influence  on  the  direction  of  productive  activities 
as  you  or  I.  Would  this  result  be,  abstractly  speaking,  unrea- 
sonable? Explain. 

(h)  If,  in  questions  (e),  (f)  and  (g),  we  were  to  change 
the  words  "very  silly"  to  "morally  questionable,"  would  the  re- 
sults necessarily  be  different?  Discuss  fully. 


"The  assumption  that  the  ratio  between  the  social  import- 
ances of  two  wants  is  necessarily  the  same  as  the  ratio  between 
their  absolute  magnitudes — their  feeling  quantities — is  quite 
unwarranted.  By  the  social  importance  of  a  particular  person's 
want  we  mean  the  comparative  significance  to  the  welfare  of 
persons  other  than  the  one  immediately  involved,  of  having  that 
person's  want  satisfied,  as  compared  with  the  significance  of 
having  some  other  person's  want  satisfied.  Now,  the  ratio  be- 
tween the  significances  to  the  rest  of  the  world  of  Mr.  A's 
wants  and  mine  is  more  likely,  I  fancy,  to  be  different  from  the 
ratio  between  the  absolute  magnitude  of  those  wants  than  it  is 
to  be  the  same.  Anyhow,  there  can  be  no  doubt  that  said  ratio 
might  be  different." 

(a)  Formulate    one    or    more    reasons    why    my    fellow   men 
generally  should   feel  an  interest  in  having  Mr.  A's  wants  and 
mine   satisfied    in  accord   with   their  absolute   magnitudes. 

(b)  Formulate    one    or    more    reasons    why    my    fellow   men 
generally  would  feel  an  interest  in  having  Mr.  A's  wants  satis- 
fied in  larger  proportion  than  mine. 

(c)  Can  you  imagine  a  case  in  which  the  ratio  of  the  social 
significances  of  the  wants  involved  would  naturally  be  in  inverse 
proportion  to  the  absolute  magnitudes  of  those  wants?     Explain. 

9 

Read  carefully  paragraph  (c),  p.  346,  and  show  that  the 
Principle  of  Marginal  Productivity,  which  seems  to  exploit  com- 
mon laborers,  just  as  truly  exp'oits  workers  of  higher  classes 
and  also  capitalists. 

10 

Suppose  that  Fisherman  A  spends  thirty  days  making  a  net; 
that  this  net  will  last  in  use  thirty  days ;  and  that  with  its  aid 
a  fisherman  can  catch  one  hundred  fish  each  day,  while  with 
his  hands  merely  he  could  catch  only  twenty  fish.  Suppose, 
further,  that  Fisherman  B  hires  the  net  from  A,  giving  to  the 
latter  seventeen  hundred  out  of  the  three  thousand  fish  caught, 

439 


PRINCIPLES  OF  ECONOMICS 

instead    of    fifteen   hundred,    i.e.,    just    one-half.     Argue   that    B 
cannot  reasonably  claim  that  he  is  wronged. 

11 

Some  recent  Socialists  who  have  finally  relinquished  Marx's 
Surplus  Value  theory  of  profit  and,  therefore,  need  some  new 
argument  for  their  conclusion  that  capital  exploits  labor,  have 
returned  to  the  old  popular  or  naive  theory.  Their  argument, 
which  is  not  always  very  definite,  may  perhaps  be  expressed 
in  the  following  five  propositions :  (a)  only  labor  produces  any- 
thing; (b)  capitalists  do  not  labor,  therefore,  do  not  produce 
anything;  (c)  capitalists  do,  however,  consume  products;  (d) 
capitalists,  therefore,  must  consume  products  produced  by 
labor;  (e)  hence  capitalists  exploit  labor;  that  is,  get  product 
produced  by  labor  without  giving  an  equivalent.  This  reason- 
ing can  be  attacked  either  in  Proposition  (a)  or  Proposition 
(e).  That  is,  we  can  deny  that  labor  alone  produces,  or  we  can 
deny  that  consuming  some  products  of  labor  necessarily  in- 
volves exploiting  labor,— that  is,  getting  products  of  labor  with- 
out giving  an  equivalent.  Try  to  meet  the  argument  in  both 
of  these  ways  using  any  knowledge  you  may  have  acquired  dur- 
ing the  semester  and,  more  particularly,  the  matter  given  on 
pages  64-67  and  366-368. 

12 

"I  never  see  one  of  Mr.  Carnegie's  libraries  without  being 
filled  with  indignation  at  the  thought  of  the  laborers  who  were 
exploited  by  Mr.  Carnegie  in  the  process  of  obtaining  the  weialth 
from  which  these  libraries  were  built." 

"I  consider  this  very  silly  talk.  Mr.  Carnegie's  laborers  in 
all  probability  had  no  more  claim  to  a  dollar  of  this  wealth 
than  I  have.  If  Mr.  Carnegie  exploited  anyone  in  becoming  a 
multi-millionaire,  it  was  not  his  laborers." 

(a)  Argue  for  the  correctness  of  the  second  quotation. 

(b)  Whom    did    Mr.    Carnegie   exploit,    if    anyone? 

13 

"Your  orthodox  economist  pretends  to  believe  that  the  pres- 
ent system  of  distribution  works  for  justice  in  that  it  pays 
laborers  in  proportion  to  their  efficiency.  In  reality,  employers 
pay  more  efficient  workmen  higher  wages,  or  bonuses,  or  what- 
ever it  .may  be,  not  because  justice  demands  this  policy,  but  be- 
cause the  employer  gains  thereby." 

Does  the  orthodox  economist  pretend  that  justice  is  secured, 
in  so  far  as  it  is  secured,  because  the  employer  is  seeking  to 
attain  that  end? 

14 

Suppose  that  we  have  a  small  Socialistic  community  owning 
twelve  wheat  farms  of  twenty  acres  each,  which  farms  have  a 
productivity,  when  worked  with  a  certain  amount  of  labor,  rang- 
ing from  twenty-four  bushels  per  acre,  through  twenty-three, 
twenty-two,  twenty-one,  and  so  on,  down  to  thirteen.  Suppose, 

440 


CHAPTER  XIV.    CRITIQUE  OF  PRESENT  ORDER. 

further,  that,  under  the  conditions  prevailing  at  a  given  time, 
the  best  eight  of  these  farms  can  profitably  be  worked,  and 
are  so  worked,  by  one  man  each,  viz. :  Mr.  A,  Mr.  B,  Mr.  C, 
et  al., — all  these  men  being  precisely  equal  in  productive  effi- 
ciency. 

(a)  Under  these  conditions  would  it  be  reasonable  to  impute 
any  product  to  one  or  more  of  the  pieces  of  land? 

(b)If  so,  how  much  product  for  each  one? 

(c)  Would  it  be  reasonable  to  say  that  Mr.  A   is  morally 
responsible    for    the    whole    twenty-four   bushels    raised   on    his 
farm,  even  if  he  cannot  be  credited  with  it  economically?  (That 
is.  is  Mr.  A  the  producer  in  such  a  sense  that  justice  requires 
giving  him  the  tw'enty-four  bushels?) 

(d)  Who  would  be  exploited  if  Mr.  A  were  given  the  whole 
twenty- four  bushels? 

15 

"The  proper  way  to  introduce  Socialism  is  to  increase  every 
few  years  the  taxes  on  land  and  capital,  till  the  owners  are  glad 
to  turn  them  over  to  the  state  in  fee  simple.  This  will  involve 
no  injustice,  even  on  the  principles  of  individualistic  economics; 
since,  unless  the  rate  of  taxation  on  durable  income-bearers  is 
increased  from  time  to  time,  the  owners  escape  all  taxation, 
under  the  operation  of  the  well-known  Principle  of  Backwarda- 
tion." 

(a)  Explain   and   defend   this   last   contention   as  applied   to 
land. 

(b)  Show  that  it  is  not  sound  in  the  case  of  capital. 


441 


FINAL   REVIEW. 
1. 


i. 

On  pages  3  and  4  stress  is  laid  on  the  point  that  economic 
phenomena  are  influenced  by  artificial  and  temporary  conditions 
such  as  legislation,  public  sentiment,  custom,  etc.  Illustrate 
this  point  with  some  fulness,  particularly  in  respect  to  the  ™-\^f>± 
of  goods,  the  rate  of  wages,  and  so  on. 


prices 


2. 

Why  is  it  particularly  important,  in  economic  matters,  that 
we  should  not  attempt  to  settle  concrete  social  problems,  such 
as  protection,  socialism,  trade  unionism,  etc.,  by  a  simple  appli- 
cation of  economic  principles? 

3. 

Defend  the  statement  that  the  present  economic  order  is  a 
cooperative  one. 


What  is   meant   by   saying  that  exchange  regulates  our  COT 
operation  under  the  present  order? 

5. 

Illustrate  how  a  socialistic  community  might  leave  exchange 
to  regulate  in  some  degree  its  economic  activity. 

6. 
What  is  meant  by  heterogeneous  cooperation? 

7. 
In  what  consists  the  chief  advantage  of  trade  between  nations? 

8. 
Review  probems  2,  3,  4,  pp.  13-14. 


Answer  the  question  which  begins  on  line  32,  p.  18. 

10. 

Discuss,  with  illustrations  of  your  own,  the  proof  presented 
on  p.  17  that,  under  an  exchange  regime,  each  tends  to  profit 
from  the  increased  efficiency  of  others. 

11. 

Defend  the  proposition  laid  down  on  p.  19  as  Corollary  2. 

443 


PRINCIPLES  OF  ECONOMICS 

12. 
Review  problems  2.,  4,  8,  pp.  20-21. 

13. 

Explain  what  is  meant  by  functional  specialization  or  co- 
operation, p.  23. 

14. 

In  a  great  commercial  center  like  New  York  there  are  many 
persons  who  make  a  living  as  note-brokers ;  that  is,  though  not 
running  a  bank  themselves,  they  discount  the  notes  of  business 
men  and  then  get  these  notes  rediscounted  at  some  bank.  In 
other  words,  they  act  as  middlemen,  so  to  speak,  between  banks 
and  the  borrowing  public.  Think  of  some  ways  in  which  this 
sorl:  of  specialization  might  be  useful.  How  is  it  that  such  a 
business  can  flourish  in  New  York  but  not  in  Ann  Arbor? 

15. 
Review  problems  6  and  7,  p.  24;  also  3  and  5,  p.  25. 

16. 

Provided  that,  in  respect  to  desirableness,  the  land  varies  by 
insensible  differences,  and  provided  that  there  is  a  considerable 
amount  of  land  not  yet  in  use,  then  land  on  the  margin  of  culti- 
vation will  not  be  recognized  as  economically  a  factor  in  pro- 
duction. 

(a)  Explain  what  is  meant  by  land  on  the  margin  of  culti- 
vation. 

(b)  What  is  meant,  and  what  is  not  meant,  by. saying  thaf 
such  land  is  not  "economically  a  factor  in  production?" 

(c)  Why  will  such  land  bear  no  rent? 

(d)  To  whom  will  the  product  of  such  marginal  land  nat- 
urally go  in  the  process  of  distribution? 

17. 

Be  sure  that  you  have  mastered  the  argument  given  on  page 
32  to  show  that  it  is  necessary  to  distinguish  capital  from 
simple  labor. 

18. 

What  is  meant  when  I  say :  "It  is  necessary  to  credit  a  part 
of  the  product  to  capital,  conceived  as  congealed  labor,  and 
another  part  to  capital,  as  waiting  power?" 

19. 

Argue  that  the  above  statement  in  quotation  marks  would 
be  true  under  socialism. 

20. 

On  p.  39,  line  8,  there  is  a  sentence  beginning:  "In  the 
opinion  of,  etc."  Illustrate  the  point  made  from  matters  you 

444 


FINAL  REVIEW 

have  learned  about  since  your  first  reading  of  that  page.    (Read 
carefully  the  first  paragraph  of  p.  39.) 

21. 
Review  problems  5  to  9  inclusive,  v.  41. 


"We  can  never  get  rid  of  rent;  though  we  can  fix  things 
so  as  to  have  rent  go  to  the  community,  as  a  whole,  rather  than 
to  private  individuals."  Argue  for  the  correctness  of  the  above 
statement. 

23. 
Review  problems  -2  and  4,  pp.  45-46. 

24. 

"Utility  and  disutility  costs,  being  true  opposites,  are  entirely 
commensurable."  p.  47. 
Explain  and  illustrate. 

25. 

Review  carefully  the  argument  for  the  contention  that  wait- 
ing must  be  treated  as  a  real  cost.  pp.  48-49. 


In  what   sense  is  risk  taking  one  of  the  disutility  costs   of 
production?  pp.  49-50. 

27. 
What  is  meant  by  derivative  costs? 

28. 
Review  problems,  2,  3,  5,  6,  pp.  54-55. 


Defend  the  definition  of  "produce"  given  on  p.  56. 

30. 
Illustrate  Comment  (e),  p.  58. 

31. 
Review  problems  I,  4,  5,  10,  u,  pp.  59-60. 

32. 

Give  the  chief  explanation  of  the  fact  that  more  capital- 
istic methods  are  superior  in  efficiency  to  less  capitalistic  meth- 
ods, pp.  62-64. 

33. 
Review  problems  3,  4,  p.  64. 

445 


PRINCIPLES  OF  ECONOMICS 

34. 

Be  sure  to  master  the  argument  for  the  productivity  of  cap- 
ital, pp.  64-67. 

35. 
Review  problems  2,  3,  4,  p.  70. 

36. 

Show,  by  using  some  law  of  price,  that  people  in  general 
will  naturally  gain  from  the  increased  economic  efficiency  of 
their  neighbors. 

37. 

How  do  we  get  an  argument  for  free  trade  out  of  the  prin- 
ciple that  efficiency  varies  directly  as  the  extent  to  which  spe- 
cialization is  carried? 

38. 

Construct  an  illustration  for  the  Law  of  Comparative  Cost 
under  which  the  exact  amount  of  advantage  gained  by  either 
party  to  the  exchange  might  vary  over  a  considerable  range. 

(a)  Try  to  get  out  of  this  illustration  another  argument  for 
the  doctrine  that  we  profit  from  the  increased  efficiency  of  our 
neighbors. 

(T>)  Defend  the  statement  that,  in  a  sense,  all  economic  co- 
operation involves  mutual  exploitation.  (That  is,  each  "works" 
the  other ; — gets  something  which  naturally  belongs  to  the 
other). 

39. 
Review  problems  7  and  8,  p.  78,  and  2,  p.  79. 

40. 

Distinguish  Integration  of  Industries  and  Consolidation.  If 
you  prefer  to  employ  the  designations  "horizontal  combination" 
and  "vertical  combination,"  which  phrase  would  you  use  to 
cover  Integration? 

41.  ' 
Review  the  six  problems  on  p.  86. 

42. 
Review  problems  2,  3,  pp.  90-91. 

43. 
Review  problems  2.,  3,  p.  92. 

44. 
Review  problems  7,  8,  p.  99. 


FINAL  REVIEW 

45. 

"The  principle  appearing  at  the  top  of  p.  109  shows  that  the 
one  laid  down  on  p.  107  is  largely  hypothetical."  Explain. 

46. 

"However,  the  two  principles  given  on  p.  112  show  that  the 
one  on  p.  107  is  not  wholly  hypothetical."  Explain. 

47. 
Review  problems  4,  5,  7,  8,  p.  115. 

48. 

What  is  the  theoretic  problem  which  Section  B,  Chapter  4, 
attempts  to  solve? 

49. 

Review  problems  2,  5,  7,  8,  p.  121. 

50. 

What  is  the  theoretic  problem  which  Section  C,  Chapter  4, 
attempts  to  solve? 

51. 
Review  all  the  problems  p.  127. 

52. 

Explain  carefully  what  is  meant  when  it  is  said  that  a  par- 
ticular thing  acts  as  a  medium  of  exchange. 

53. 

Be  sure  to  master  the  second  half  of  p.  129  and  the  whole 
of  p.  130. 

54. 

Review  problems  2,  4,  7,  p.  131. 

55. 

Near  the  foot  of  p.  132  is  given  a  characterization  of 
credit-exchange  as  being  the  process  of  "bringing  about  in  some 
way,  etc."  Prepare  yourself  to  show  clearly  that  this  is  the 
essential  peculiarity  of  all  forms  of  credit-exchange;  check- 
exchange,  bank  clearing,  and  interlocal  exchange. 

56. 

Review  carefully  the  discussion  of  the  rate  of  exchange  on 
pp.  136-137- 

57. 

On  p.  138,  it  is  said  that  a  Commercial  Bank  of  the  English 
or  American  type  "may  be  described,  in  general,  as  an  institu- 
tion which  acts  as  a  common  treasurer  or  fiscal  agent  for  such 

447 


PRINCIPLES  OF  ECONOMICS 

part  of  the  general  public  as  care  to  patronize  it."     Argue  for 
the  propriety  of  this  description. 

58. 
Review  problems  10  to  16  inclusive,  p.  140. 

59. 

On  page  142,  it  is  said  that  the  money  stage  of  capital  'is  only 
the  representative  form  of  capital,  the  shadow  or  image,  not 
the  substance." 

(a)  Explain  what  is  meant. 

(to)  Are  we  to  understand  from  this  that  the  circulating 
medium  of  a  country  is  not  itself  capital? 

60. 
Review  problems  i,  5,  7,  g,  12,  pp.  144-146. 

61. 
Review  problems  2,  3,  5,  7,  n,  13,  14,  15,  pp.  149-151. 

62. 
Review  carefully  Comment  3,  pp.  152-153. 

63. 

Be  sure  you  master  the  argument  for  the  Principle  of  Reci- 
procity, pp.  153-157. 

64. 

Review  problems  I,  5,  6,  9,  n,  12,  14,  15,  17,  19,  20,  21,  pp. 
158-161. 

65. 

Suppose  we  agree  to  name  the  valuations  or  utilities  of  the 
excluded  buyers  or  sellers  extra-marginal  valuations  or  utilities, 
and  also  agree  to  name  the  valuations  or  utilities  of  the  in- 
cluded buyers  or  sellers,  except  the  marginal  ones,  intra-mar- 
glnal — these  adjectives  being  also  applied  to  the  buyers  and 
sellers  themselves. 

(a)  Under  this   nomenclature   which   buyers   in   the    "wood" 
schedule,  p.   177,  would  be  extra-marginal  and  which  intra-mar- 
ginal  ? 

(b)  Which  sellers  would  be  extra-marginal  and  which  intra- 
marginal? 

66. 

"Only  one  among  the  extra-marginal  valuations  on  the  supply 
side  has  any  part  in  fixing  price." 

(a)  Which  is  that  one,  and  how  does  it  influence  price? 

(b)  Show  that  the  others  do  not  share  in  fixing  price. 

67. 

"Only  one  among  the  extra-marginal  valuations  on   the   de- 

448 


FINAL  REVIEW 

mand  side  has  any  part  in  fixing  price.'' 

(a)  Which  is  that  one,  and  how  does  it  influence  price? 

(b)  Show  that  the  others  do  not  share  in  fixing  price. 

68. 

"The  statement  that  the  going  price  must  be  one  which 
equates  demand  and  supply  is  little  more  than  an  identical 
proposition ;  for  demand  is  what  is  bought  and  supply  is  what 
is  sold,  and,  obviously,  these  are  the  same  thing  looked  at  in 
two  different  ways." 

(a)  Show  that   supply  and   demand  are  two  quite  different 
things  in  respect  to  their  nature. 

(b)  Show   that  they   are   quite    different,    quantitatively  con- 
sidered, i.e.,  are  unequal,  save  at  one  particular  price. 

69. 

Define  normal  price.  Show  that  we  can  properly  speak  of 
a  normal  price  for  non-producible  goods. 

70. 
Define  increasing-cost  goods. 

71. 
Illustrate  the  principle  at  the  foot  of  page  242. 

72. 
Review  problems  2,  3,  5,  pp.  245-246. 

73. 

The  table  below  gives  portions  of  imaginary  supply  and  de- 
mand schedules  for  silver.  Under  Output  Schedule  I  and  De- 
mand Schedule  A,  the  price  would  tend  to  be  53  cents.  Show, 
by  making  different  combinations  among  the  schedules,  that,  in 
this  case,  marginal  cost  does  not  merely  adjust  itself  to  a  price 
fixed  by  marginal  utility, — that,  on  the  contrary,  marginal  cost 
plays  an  essential  part  in  determining  price. 


Possible 
Output 
mil.  oz. 
Sch.  II 

Possible 
Output 
mil.  oz. 
Sch.  I 

Cost  or 
Utility 
cents 

Demand 
mil.  oz 
Sch.  A 

Demand 
mil.  oz. 
Sch.  B. 

260 
260 
220 
220 
220 
220 
220 
160 
160 

250 
245 
240 
235 
230 
225 
220 
215 
210 

59 
58 
57 
56 
55 
54 
53 
52 
51 

190 
195 
200 
205 
210 
215 
220 
225 
230 

200 
205 
210 
215 
220 
225 
230 
235 
240 

449 

PRINCIPLES  OF  ECONOMICS 

74. 
Be  sure  to  master  the  argument  on  the  middle  of  page  249. 

75. 

Construct  for  the  "tea"  problem  a  new  supply  schedule  under 
which  marginal  cost  would  share  in  the  determination  of  price. 
Explain. 

76. 

Construct  a  series  of  schedules  analogous  to  those  given  in 
the  last  problem  to   bring  out  the  converse   of  the  point  there 
made:  i.e.,  to  bring  out  the  point  that  marginal  utility  does  not 
merely  coincide  with  price  but  also  plays  an  essential  part  in 
fixing  price. 

77. 

"While  the  law  that  price  tends  to  equal  money  cost  of  pro- 
duction cannot  properly  be  looked  on  as  going  to  the  bottom  of 
the  matter,  it  is  after  all  of  great  practical  importance  in  various 
connections." 

Illustrate  for  some  of  these  connections. 

78. 
Review  problems  2,  5,  6,  7,  8,  pp.  251-253. 

79. 
Review  problem  10,  p.  253. 

80. 
Read  carefully  the  note  at  the  foot  of  p.  254. 

81. 

The  table  given  below  represents  portions  of  the  output  and 
demand  schedules  for  a  certain  rare  brand  of  tobacco.  On  the 
basis  of  this  table,  answer  the  following  questions : 


Output 
Ibs. 

Cost  or  Utility 
dollars 

Demand 
Ibs. 

1,171.51 

4.00 

500 

1,171.50 

3.50 

1,000 

1,171 

3.00 

1,200 

1,170 

2.50 

1,400 

1,168 

2.00 

1,800 

1,165 

1.50 

2,500 

1,160 

1.00 

3,000 

1,150 

.50 

6,000 

1.100 

.30 

15,000 

1,000 

.20 

40,000 

(a)  What  price  will,  tend  to  prevail?     Prove. 

(b)  What  will  be  the  marginal  cost?     The  marginal  utility? 

(c)  Which  of  the  two  will  determine  price?     Prove.     (This 
is  the  important  and  difficult  part.) 

450 


FINAL  REVIEW 

(d)  How  does  the  other  come  to  be  what  it  is? 

82. 
Review  very  thoroughly  all  the  problems  given  on  pp.  258-259. 

83. 

"I  own  a  steamer  which  runs  between  New  York  and  the 
Mediterranean  ports;  which  steamer  I  wish  to  sell.  It  has 
been  earning  for  several  years  a  net  income  of  $25,000  per  year. 
This  fact  surely  warrants  my  asking  for  said  steamer  a  price 
of  $500,000." 

Is  the  reason  he  gives  for  considering  the  steamer  worth 
$500,000  a  valid  one?  Why? 

84. 

Illustrate  the  point  that  producible  goods  may  at  times  come 
under  the  principle  laid  down  on  page  265. 

85. 

Explain  why,  in  working  out  a  complete  theory  of  prices, 
we  are  finally  driven  to  ask  ourselves  how  the  prices  of  the 
ultimate  cost  goods  are  determined,  pp.  272-275. 

86. 

Discuss  the  meaning  of  the  last  sentence  of  the  first  paragraph 
of  page  275. 

87. 

Under  the  hypothesis  appearing  on  pages  275-276,  what  would 
determine  the  prices  of  supra-marginal  products?  Answer  the 
same  question  for  the  hypothesis  on  pages  281,  287,  and  294. 

88. 

Develop  the  point  given  on  page  282-283  that,  under  one  -hypo- 
thesis as  to  the  relation  between  our  wants  and  our  capacities, 
value  would  ultimately  be  determined  by  disutility  cost  alone. 

89. 

Explain  why  it  is  very  difficult  under  the  present  order  to 
discover  the  several  contributions  of  the  several  productive 
factors,  pp.  287-288. 

90. 

In  the  principle  given  on  page  296,  it  is  said  that  "there 
tends  to  be  established  a  coherent  system  of  prices,"  etc.  What 
is  the  point  of  saying  "a  coherent  system  of  prices?" 

91. 

What  do  you  suppose  is  meant  by  the  phrase  "A  Theory  of 
Imputation?" 

451 


PRINCIPLES  OF  ECONOMICS 

92. 

Try  to  get  out  of  Problem  17,  p.  354,  a  theory  of  imputation 
for  labor  and  land  under  the  very  simple  hypothesis  laid  down 
in  that  problem. 

93. 

Why  do  we  call  our  theory  of  imputation  the  Automatic 
theory? 

94. 

"We  use  the  imaginary  equations  given  on  pages  289-291  chief- 
ly to  prove  that  our  problem  is  a  reasonable  one."  'Explain. 

95. 
Be  sure  to  master  the  argument  on  pages  291-293. 

96. 

On  what  question  turns  the  decision  of  the  controversy  as 
to  whether  disutility  cost  does  or  does  not  share  in  fixing  price? 
pp.  298-300. 

97. 

"Disutility  plays  more  or  less  part  in  regulating  our  economic 
conduct  in  a  reasonable  way;  but  it  does  not  influence  price." 
What  do  you  suppose  is  meant? 


Review  the  four  problems  on  pages  300-301. 

99. 
Review  the  five  problems  on  pp.  302-303. 

100. 

Be  sure  to  master  the  refutation  of  the  labor  theory  of 
value,  pp.  303-305. 

101. 
What  is  the  most  essential  feature  of  Socialism? 

102. 
Review  problems  3,  5,  7,  9,  10,  n,  pp.  269-270. 

103. 

What  do  we  mean  by  the  monetary  standard?  Explain  the 
difference  between  the  immediate  and  the  ultimate  monetary 
standard. 

104. 

In  Principle  I,  page  314,  occur  these  words,  "which  has  its 
value  fixed  independently  of  its  relations  to  other  moneys." 

452 


FINAL  REVIEW 

Explain  what  is  meant  and  show  the  need  for  such  a  qualifica- 
tion. 

105. 
Review  problems  I,  2,  3,  page  315. 

106. 
Review  the  five  problems  pp.  316-317. 

107. 

The  Philippine  mint  had  a  ratio  for  gold  and  silver  coin  of 
33.25  to  1  when  the  market  ratio  was  31  to  1.  Which  metal  was 
overrated  ? 

Suppose  the  market  ratio  had  been  40  to  1,  which  metal 
would  have  been  underrated? 

Suppose  the  market  ratio  had  been  31.8  to  1,  which  metal 
would  have  been  overrated? 

With  our  ratio  of  16.98  to  1,  which  metal  is  underrated  when 
the  market  is  15.82  to  1? 

Our  subsidiary  coin  ratio  is  14.95  to  1;  which  metal  does  it 
underrate? 

108. 
Review  problems  I,  2,  3,  under  Principle  III,  pp.  317-318. 

109. 
Review  problem  3,  under  Principle  IV,  p.  318. 

110. 
Review  problems  i,  4,  5  and  6,  pp.  321-322. 

111. 

Be  sure  that  you  master  the  argument  under  Principle  X, 
page  324. 

112. 

In  Principle  XII,  p.  325,  we  read  "circumstances  may  arise 
under  which  it  is  desirable,  etc."  Explain  and  illustrate. 

113. 
Review  problems  2,  5,  7,  pp.  326-327. 

114. 

How  is  it  that  we  have  an  important  problem  in  connection 
with  the  value  of  money,  seeing  that  said  value  is  fixed  by  the 
ultimate  standard?  pp.  327-329. 

115. 

Review  carefully  Principles  XV,  XVI  and  their  corollaries, 
PP.  330-333- 

116. 
Review  carefully  the  15  problems  on  pp.  333-335. 

453 


PRINCIPLES  OF  ECONOMICS 

117. 

Review  the  three  problems,  page  309,  and  the  one  problem  p. 
312. 

118. 

Review  problems  i,  3;  5,  pp.  337-338,  and  problems  I,  2,  4,  p. 
339- 

119. 

Try  to  think  of  some  way  to  diminish  the  force  of  the  con- 
tention which  appears  in  problem  5,  p.  339. 

120. 

The  point  brought  out  in  Comment  (•£),  pp.  343-344,  that  the 
supplying  of  the  land  factor  in  production  involves  a  derived 
disutility,  is  important  from  the  standpoint  of  one  who  believes 
in  interest,  in  that  it  supplies  an  argument  for  the  legitimacy 
of  private  rent  under  normal  conditions.  Develop  that  argu- 
ment. Show  that  there  still  remains  a  difference  between  land 
and  capital,  rent  and  interest,  which  makes  the  legitimacy  of 
rent  more  doubtful  than  that  of  interest. 

121. 

"I  have  no  patience  with  the  idea  that  free  competition  be- 
tween units  so  unequal  as  capital  and  labor  can  bring  about  fair 
results."  Criticize. 

122. 
Review  carefully  the  argument  under  Corollary  3,  pp.  347-348. 

123. 
Review  carefully  the  two  notes  on  pages  348-349. 

124. 

Near  the  middle  of  page  350  occurs  this  sentence :  "The 
principle  as  stated  says  .  .  .  might  increase  the  returns  per 
unit  of  service  performed,  but  not  per  person."  Substitute  for 
the  words  "per  person"  these:  "the  wages  per  day."  Try  to 
find  out  whether  or  not  the  statement  would  then  be  true. 

125. 
Illustrate  Corollary  6,  page  350. 

126. 

Illustrate  the  point  made  in  the  second  part  of  the  note 
under  Corollary  8,  page  351. 

127. 

Review  problems  2,  3,  4,  5,  6,  7,  8,  13,  14,  16,  19,  22,  23,  pp. 
352-355- 

454 


FINAL  REVIEW 

128. 
Don't  overlook  the  Corollaries  on  pages  355-357. 

129. 
Be  ready  with  the  arguments  for  the  principle  on  page  358. 

130. 

Connect  the  discussions  under  3,  pp.  359-360,  with  that  given 
in  Section  C,  Chapter  4,  pp.  122-127. 

131. 
Review  problems  I,  3,  4,  6,  7,  8,  9,  pp.  361-363. 

132. 
Review  problems  2,  3,  4,  p.  369. 

133. 

Review  the  following  problems — 5,  6,  8,  p.  41 ;  2,  4,  pp.  45,  46 ; 
3,  5,  6,  p.  55;  4,  11,  pp.  58-59;  i,  2,  3,  4,  p.  64;  i,  2,  3,  p.  70;  2,  p. 
372. 

134. 

"In  general,  intra-marginal  valuations,  whether  on  the  demand 
side  or  on  the  supply  side,  do  not  directly  share  in  price- 
determination.  To  this  statement,  however,  the  first  intra- 
marginal  valuation  on  each  side  usually  forms  an  exception." 

(a)  Defend  the  first  statement. 

(b)  Defend  the  second  statement. 

135. 

Review  the  two  principles  on  pages  373U374,  and  the  two  prob- 
lems on  the  following  page. 

136. 

Near  the  top  of  page  377,  occurs  this  sentence:  "Under 
Socialism  the  sort  of  risk  now  remunerated  by  profits  would, 
etc."  Explain  just  what  is  meant  and  v<hy  it  would  turn  out 
this  way. 

137. 

Near  the  middle  of  page  378,  we  have  this  sentence :  "The 
facts  with  respect  to  such  an  entrepreneur  are  of  no  scientific 
significance,  etc."  Explain  and  justify  the  statement. 

138. 

Under  normal  conditions  industries  like  transportation  earn 
profits  considerably  in  excess  of  what  would  naturally  be  ex- 
pected in  view  of  the  actual  investments.  In  order,  therefore, 
to  estimate  the  real  value  of  these  businesses  it  is  customary 
to  capitalize  the  net  income  as  in  the  case  of  non-producible 
income-bearers.  In  Michigan  at  the  present  time,  many  auto- 

455 


PRINCIPLES  OF  ECONOMICS 

mobile  companies  are  showing  a  similar  phenomenon ;  that  is, 
they  are  getting  profits  far  in  excess  of  what  the  investment 
would  lead  us  to  expect.  Accordingly,  the  Michigan  Tax  Com- 
mission proposes  to  use  the  same  method  for  ascertaining  the 
real  value  of  such  businesses  as  that  used  in  the  case  of  rail- 
roads, only  the  Commission  recommends  using  a  higher  rate 
of  capitalization  for  the  automobile  companies  than  for  the 
railroads.  Try  to  find  the  reason  for  making  this  difference. 

139. 

Study  very  carefully  the  note  beginning  at  the  bottom  of 
page  382. 

140. 

Review  the  argument  against  the  notion  that  profits  tend  to 
disappear. 

141. 
W'hat  is  the  point  of  the  foot-note  on  page  387? 

142. 
Review  carefully  pages  390-399. 

143. 

"Taking  up  again,  for  a  moment,  the  controversy  brought 
out  on  page  396,  there  can  'be  no  reasonable  doubt  that  the 
economist  has  a  right,  from  the  purely  scientific  standpoint,  to 
study  the  question:  Does  the  economic  system  work  well?,  pro- 
vided he  limits  his  investigation  to  the  fitness  of  that  system 
to  accomplish  economic  ends.  His  situation  is  at  this  point 
precisely  analogous  to  that  of  the  physiologist  who,  just  be- 
cause he  is  a  physiologist,  is  all  the  time  studying  the  fitness  of 
means  to  attain  ends ;  but  who,  of  course,  limits  his  attention 
to  a  consideration  of  the  biological  ends,  i.e.,  the  maintenance 
of  life  and  health.  The  only  question  upon  which  issue  can 
properly  be  taken  with  us  is  this :  Is  it  legitimate  for  the  econo- 
mist to  attempt  to  pass  judgment  on  the  present  order  in  re- 
spect to  its  fitness  to  accomplish  the  ends  recognized  as  ethically 
valid?" 

(a)  Defend  and  illustrate  the  point  that  the  physiologist,  as 
such,    is    called   on    to   pass    judgment    on    the   working    of   life 
forces. 

(b)  Give  illustrations  of  points  made  by  the  economist  with 
respect   to   the   workings   of   things   which   are   certainly  within 
his  proper  field. 

(c)  Give    illustrations   of    cases   which   one    may   reasonably 
view  as  properly  placed  outside  his  field. 

144. 

Probably  the  greatest"  weakness  in  the  regulative  machinery 
of  the  present  economic  order  is  its  failure  to  secure  steadiness, 

456 


FINAL  REVIEW 

regularity,  in  economic  activity.  The  economic  organism  is 
one  year  working  like  a  man  under  the  influence  of  an  alcoholic 
stimulant;  the  next  it  is  moving  like  a  hopeless  invalid.  Try 
to  think  of  ways  in  which  government  could  improve  matters 
at  this  point  without  going  so  far  as  to  replace  the  present 
automatic  system  with  Socialism. 

145. 

Amplify  and  illustrate  the  two  sentences  which  occupy  lines 
14-25,  p.  400. 

146. 

Be  sure  to  master  the  argument  'of  the  paragraph  which 
occupies  the  middle  of  p.  401. 

147. 
Illustrate  at  length  the  second  paragraph  on  p.  401. 

148. 

Review  carefully  the  argument  on  pages  406-411  supporting 
the  contention  that  one  could  not  afford  to  enforce  complete 
equality  in  distribution. 

149. 
Illustrate  the  point  suggested  in  the  footnote  on  p.  411. 

150. 

Give  some  reasons  for  believing  that,  as  suggested  on  p.  411, 
inequalities  in  income  would  be  very  much  reduced  under  So- 
cialism, and  without  great  harm  resulting. 

151. 

Show  that  the  Social  Service  ideal  of  distribution,  conceived 
as  excluding  the  idea  that  the  rich  man's  wants  are  more  im- 
portant than  the  poor  man's,  is  self-contradictory  (p.  412). 

152. 
Review  carefully  the  argument  under  A,  p.  413. 

153. 

Review  carefully  the  argument  (pages  417-419)  to  show  that 
interest  would  be  a  legitimate  share,  supposing  the  community 
to  be  the  sole  capitalist. 

154. 
Show  that  rent  would  have  to  exist  under  Socialism. 

155. 

Be  sure  to  master  the  Surplus-Value  theory  of  profits,  pp. 
428-430. 


457 


APPENDIX  I 
MISCELLANEOUS  PROBLEMS. 

1 

A  recent  writer  (not  an  economist),  in  setting  forth  the 
wastes  of  competition,  has  maintained,  though  with  little  or  no 
argument,  that,  in  so  far  as  exchange  means  nothing  more  than 
that  different  producers  bring  each  his  product  to  a  common 
store  and  take  away  each  an  equivalent,  such  exchange  is  nec- 
essary, legitimate,  productive;  but,  in  so  far  as  exchange  means 
what  he  quite  improperly  calls  barter,  dickering  over  and  finally 
settling  on  a  ratio  of  exchange  between  what  one  brings  and 
what  he  takes  away,  it  is  not  necessary  or  legitimate  or  pro- 
ductive. Show  that  such  a  doctrine  is  quite  untenable. 

2 

A  certain  Detroit  grocer  who  is  a  Socialist  and  no  longer 
young  often  expresses  regret  that  the  obligation  to  support  a 
family  compels  him  to  continue  in  an  occupation  which  makes 
him  a  "parasite" — one  who  lives  on  others,  consumes  without 
producing. 

Show  with  details  that  he  probably  is  not  a  parasite. 

3 

It  is  often  said  that  capital  and  labor  are  each  indis- 
pensable to  the  other.  Illustrate  the  point. 

4 

As  social  and  industrial  development  advances,  special- 
ization and  so  cooperation  go  further  and  further.  Try  to- 
think  of  several  examples  of  specialization  carried  to  a  notable 
degree.  If  possible,  choose  cases  from  your  own  experience. 


5 

Illustrate  the  proposition  that  the  working  of  the  present 
economic    order    involves    freedom    of    contract    between    indi- 


6 

One  eminent  American  economist  is  disposed  to  define 
capital  as  "inchoate  goods,"  i.e.,  goods  in  the  process  of  becom- 
ing goods. 

(a)  Mention  some  forms  of  capital  to  which  that  phrase  is 
especially  appropriate. 

459 


PRINCIPLES  OF  ECONOMICS 

(b)  Try  to  make  a  plausible  argument  to  show  that  the  phrase 
applies  fairly  well  even  to  a  thing  like  a  sewing  machine. 

7 

.  It  has  always  been  held  that  a  pound  of  candy  is  capital 
while  it  is  still  in  the  hands  of  the  merchant,  although  almost 
all  writers  say  that  it  ceases  to  be  capital  when  it  passes  into 
the  hands  of  some  consumer.  Argue  for  the  reasonableness  of 
the  first  position. 

8 

A  good  many  American  economists  are  inclined  to  look 
on  capital,  in  one  sense  anyhow,  as  a  fund  of  money  value  em- 
bodied in  goods.  That  is,  they  prefer  not  to  call  the  literal 
engine  capital,  but  to  reserve  this  word  for  the  $2,000  of  value  in 
the  engine. 

(a)  How  does  this  compare  with  business  usage? 

(b)  Does  it  seem  natural  or  useful  in  any  way? 

(c)  Some  who  answer  the  last  question  affirmatively  yet  insist 
that  such  language  is  only  figurative,  and,  besides,  rather  dan- 
gerous.    Argue  for  both  these  points. 

9 

One  eminent  economist  proposed  to  include  under  capital 
only  surplus  supplies  of  subsistence.  Another  agreed  with  him 
so  far  as  to  affirm  that  all  capital  is,  in  the  last  analysis,  redu- 
cible to  means  of  subsistence,  even  food, — that,  so  to  speak,  the 
first  incarnation  of  every  new  piece  of  capital  is  a  surplus  of 
subsistence.  Probably  the  majority  of  economists  would  hesitate 
to  go  so  far;  but  all  would  admit  that  there  is  some  truth  in 
this  way  of  putting  the  case. 

(a)  Show  that,  in  a  primitive  community,  the  increasing  of 
capital  naturally  begins  with  the  accumulation  of  a  surplus  sub- 
sistence fund. 

(b)  Argue  for  the  proposition  that  there  is  a  sense  in  which 
the  whole   stock   of  capital,    engines,    fuel,   raw   materials,    etc., 
can  be  conceived  as  a  subsistence  fund.     (Read  Boehm-Bawerk's 
Positive  Theory  of  Capital,  pp.  321-322.) 

(c)  On   the   basis   of   that   conception    of   subsistence    fund, 
argue  for  the  proposition  that  new  capital  has  to  begin  with  a 
surplus  subsistence  fund. 

10 

Argue  in  favor  of  the  contention  referred  to  on  page  41 
that  we  could  reasonably  include  under  capital  durable  goods 
which  are  devoted  to  supplying  consumption  service  to  the 
owner,  e.  g.,  a  dwelling  owned  and  occupied  by  himself. 

ii 

Give  illustrations  of  your  own  of  fixed  capital,  social 
capital,  specialized  capital,  acquisitive  capital. 

460 


MISCELLANEOUS  PROBLEMS 

12 

Argue  for  the  contention  that  we  should  naturally  expect 
the  rate  of  interest  to  be  determined  in  the  first  instance  by  the 
supply  of,  and  the  demand  for,  free,  rather  than  invested,  capi- 
tal. Would  you  expect  the  quantity  of  invested  capital,  repre- 
sented in  buildings,  engines,  machines,  etc.,  to  have  an  indirect 
influence  on  the  rate  of  interest?  Explain. 

13 

"A  wise  government  will  never  let  a  dollar  in  money  go 
out  of  the  country;  for,  as  every  dollar  spent  by  an  individual 
makes  him  so  much  poorer,  so  every  dollar  paid  out  by  the 
country  to  other  countries  makes  the  first  country  so  much 
the  poorer." 

(a)  ]n   what    sense   must   the   word   "spent"   be    understood 
to  make  the  case  of  the  individual  and  the  country  parallel? 

(b)  When  used  in  this  sense,  is  it  true  that  every  dollar 
spent  by  the  individual  makes  him  so  much  poorer? 

14 

Look  up  the  Torrens'  Land  Title  system  (some  cyclo- 
pedia), and  see  if  its  adoption  would  tend  to  increase  the  availa- 
bility of  capital. 

15 

(a)  Suppose  you  had  at  your  disposal  more  A's  than  you 
could  use,  but  your  stock  of  B's  was  smaller  than  your  needs; 
what  combination  would  you  naturally  use? 

(b)  Reverse  the  places  of  A  and  B,  and  answer  the  above 
question. 

16 

The  combinations  of  our  table  from  1  to  8  have  an  excess 
of  A's ;  those  from  20  to  27  have  an  excess  of  B's.  How  would 
you  describe  those  from  9  to  19,  from  this  same  standpoint  of 
the  excess  of  one  or  the  other  factor? 

17 

Combination  9  gives   us   the  point  of  maximum   efficiency 
for  A's,  and  that  of  maximum  returns  for  B's.    Combination  19, 
on  the  other  hand,  gives  us  the  point  of  maximum  returns  for 
A's  and  that  of  maximum  efficiency  for  B's. 
Explain  fully  what  these  statements  mean. 

18 

In  his  Economics  of  Industry,  p.  323,  Marshall  says  that 
"the   agents   of  production  are  the   sole   source   of  employment 
for  one  another"  and  that  "an  increase  of  capital  enriches  the 
field  for  the  employment  of  labor." 
Discuss  these  statements. 

19 
Try  to  show  that  capital  as  a  whole  certainly  is  not  at 

461 


PRINCIPLES  OF  ECONOMICS 

the  point   of    maximum   efficiency   or   at  that   of    maximum   re- 
turns. .  . 

20 

Would  a  divisible  factor  ever  be  used  in  the  post- 
maxima  stage,  e.g.,  the  stage  wherein  the  return  to  that  factor 
was  absolutely  decreasing  because  of  the  excess  of  the  other 
factor  ? 

21 

Telephone   engineers   are   credited   with   the   opinion  that 
their  industry  is,  broadly  speaking,  an  increasing  cost  industry. 
Argue  for  and  against  this  opinion. 

22 

"With  all  respect  to  the  contrary  opinions  of  some  re- 
formers, it  can  not  be  doubted  that  with  the  great  advance  in 
productive  efficiency,  the  economic  lot  of  the  masses  of  work- 
ingmen  has  decidedly  improved  during  the  last-  fifty  years." 

Argue  for  the  proposition  that,  assuming  the  same  advance  in 
industrial  technique,  the  lot  of  the  masses  would  have  been 
still  better  had  their  numbers  increased  much  less. 

23 

"I  can  not  understand  the  stress  laid  by  economists  on 
the  importance  of  checking   the  growth   of  population.     Every 
person  born  into  the  world  brings  with  him  not  only  a  need  for 
goods  but  also  the  power  to  produce  these  goods." 
Show  that  this  is  not  quite  adequate. 

24 

Mill  says  that  the  law  of  diminishing  returns  asserts,  in 
effect,  that  the  limit  set  to  the  productive  capacity  of  a  country 
is  an  elastic  one. 

Argue  for  the  propriety  of  this  method  of  expression. 

25 

"A  country  gains  by  foreign  trade  only  on  condition  that 
its  imports  exceed  its  exports — it  gets  more  than  it  gives." 

The  Principle  of  Reciprocity  tells  us  that  the  above  condition 
can  not  be  fulfilled.  However,  one  might  admit  that  there  is  a 
sense  in  which  imports  must  always  exceed  exports  to  make 
trade  profitable.  Explain. 

26 

"The  one  remaining  chief  foundation  for  national  wealth 
is  commerce.  While  individual  wealth  may  be  aquired  through 
internal  commerce,  only  foreign  commerce  can  add  to  the  na- 
tional wealth  (a)  ;  and  then  only  if  the  nation  receives  more 
than  it  gives  (b).  So  the  fact  that  there  is  a  large  and  active 
commercial  class  in  japan  does  not  necessarily  imply  the  exist- 

462 


MISCELLANEOUS  PROBLEMS 

ence  of  a  national  asset.  To  the  extent  that  a  nation  is  compelled 
to  purchase  abroad  articles  necessary  to  its  national  existence 
in  excess  of  articles  produced  in  the  country  and  exported  to 
pay  for  them  it  loses  commercially  by  the  transaction  (c).  This 
difference,  where  it  occurs,  is  usually  called  the  balance  of  trade. 
Without  attempting  to  discuss  the  economic  principles  involved, 
it  suffices  here  to  say  that  at  present  Japan's  purely  commercial 
activities  do  not  constitute  a  national  asset,  for  the  balance  of 
foreign  trade  is  against  the  country.  This  condition  has  existed 
for  twenty  years  now,  and  there  is  no  prospect  of  a  change. 
Consequently,  Japan's  foreign  commerce  must  now  be  figured 
as  a  national  liability." 

Criticise  the  clauses  marked  fa),  (b),  and  (c). 

27 

.  Give  one  or  more  reasons  why  it  may  be  desirable  tu 
patronize  your  home  dealers  rather  than  Montgomery  Ward 
&  Co.,  even  though  you  consider  the  reasons  usually  given  for 
such  a  policy  quite  fallacious. 

28 

'Tor   a   long  period   Great    Britain   has   imported   more 
commodities  than   she  has  exported.     This  cannot  continue  in- 
definitely.    One  of  these  days  she  will  be  bankrupt." 
Is  that  sound? 

29 

"One  of  the  most  serious  objections  to  the  Chinaman  is 
that,   even  while  he  stays  in  this  country,  he  consumes   mostly 
commodities  which  must  be  imported   from   China;   so  that  his 
wages   go   to    support,   not   American,   but   Chinese   industries." 
Explain  fallacy. 

30 

"If  the  rate  of  interest  on  a  certain  class  of  loans  remains 
for  a  long  period  at  5  per  cent,  it  is  reasonable  to  affirm  chat 
this  figure  expresses  at  the  same  time  the  marginal  utility  of  a 
year's  use  of  one  dollar  of  capital,  and  the  marginal  disutility 
of  supplying  that  capital." 

Construct  a  supply  schedule  for  money  capital  arid  a  demand 
schedule  under  which  the  rate  of  interest  would  tend  to  be  jast  5 
per  cent,  and  would  at  the  same  time  express  the  marginal  utility 
of  capital  and  the  marginal  disutility  of  supplying  it. 

31 

"If  all  day-laborers  should  agree  to  work  with  one  hand 
ded  behind  them,  would  their  wages  go  up  or  down?  Wou'd  it 
oe  good  or  bad  for  this  whole  class  of  laborers?"  (Fetter) 

32 

One  of  Professor  Clark's  favorite  phrases  is  "functional 
distribution."  What  do  you  suppose  he  means  by  ii? 


PRINCIPLE'S  OF  ECONOMICS 

33 

"Capital  might  have  become  so  abundant  as  to  command  no 
price  except  as  congealed  labor." 

Explain  what  is  meant. 

34 

"In  the  case  of  intermediate  goods,  value  is  influenced,  in 
so  far  as  demand  plays  a  part,  only  by  income." 

Explain  what  is  meant. 

35 

"Nothing  can  be  .more  incorrect  than  to  extend  this  reason- 
ing (that  price  is  governed  by  the  law  of  supply  and  demand), 
as  many  political  economists  have  done,  to  periods  of  unlimited 
duration."  McCulloch  in  Ed.  Rev.  Vol.  30,  page  61. 

Show  that  iMcCulloch's  opinion  is  unsound  at  this  point. 

36 

"The  valuation  of  an  object  is  nothing  more  or  less  than 
the  affirmation  that  it  is  in  a  certain  degree  of  comparative  es- 
timation with  some  other  specified  object;  and  any  other  object 
possessed  of  value  may  serve  as  a  point  of  comparison."  Say, 
Political  Economy,  page  284. 

Argue  against  the  reasonableness  of  limiting  valuation  so 
narrowly  as  is  done  in  the  above  quotation. 

37 

"The  idea  of  value  entered  into  the  world  for  the  first  time 
when  a  man  said  to  his  brother,  vDo  this  for  me,  and  I  will  do 
this  for  you';  they  had  come  to  an  agreement:  then,  for  the 
first  time,  we  could  say  the  two  services  exchanged,  — were 
worth  each  other."  Bastiat. 

Show  that  Bastiat's  own  language  implies  that  he  has  in 
the  back  ground  an  absolute  conception  of  value,  instead  of  the 
purely  relative  one  that  he  declares  to  be  the  only  one. 

38 

"Whoever  thinks  of  utility  without  thinking  of  cost,  simply 
neglects,  in  the  utility  of  one  product  the  utility  of  the  other." 
Von  Wieser,  page  183. 

(i)  In  what  sense  is  cost  used  in  the  above  paragraph? 

(21)  Amplify  the  point  made  by  the  writer. 

39 

"Thus  I  venture  v  to  adhere  to  the  opinion  that  distribution 
and  exchange  are  fundamentally  the  same  problem,  looked  at 
from  different  points  of  view,  etc."  Marshall,  Economic  Jour- 
nal, Vol.  VIII,  page  47. 

Argue  for  the  correctness  of   Professor  Marshall's  opinion. 

40 
"Every  such   difference    (in  the   rate   of  interest)    implies   a 

464 


MISCELLANEOUS  PROBLEMS 

?* 

violation  of  the  very  first  principle  of  employing  goods :  that 
they  shall  first  'be  used  in  the  most  favorable  employment,  and 
that  the  less  favorable  shall  be  allowed  only  in  so  far  as  there 
is  not  enough  of  the  most  favorable."  Von  Wieser,  page  146. 
Argue  for  the  soundness  of  the  above  contention. 

41 

"No  socialist  state,  for  instance,  could  provide  houses  in 
such  quantities  that  their  value  was  reduced  to  the  mere  ex- 
penses of  building,  without  disturbing  the  marginal  plane,  and 
diminishing  the  total  sum  of  satisfaction  obtainable  by  the  em- 
ployment of  the  national  capital."  Von  Wieser,  page  158,  Note 
by  Smart. 

Argue  for  the  correctness  of  that  statement. 

42 

"If  the  payment  of  any  amount  due  is  deferred  for  some 
time,  it  is  only  fair  that  a  little  more  should  be  paid  to  com- 
pensate the  creditor  for  being  deprived  so  long  of  the  money 
to  which  he  is  entitled,  and  of  which  he  might  make  a  profitable 
use  in  buying  a  larger  stock  of  merchandise.  'This  gives  rise  to 
interest  or  compensation  for  credit."  Fiske's  The  Modern 
Bank,  pages  6  and  7. 

Show  that  such  an  explanation  of  interest  is  quite  inadequate. 

43 

"Every  properly  conducted  concern  includes  in  its  cost  of 
production  a  regular  charge  for  depreciation  of  its  plant,  prop- 
erty, and  equipment.  This  charge,  if  correctly  figured,  keeps 
the  value  of  its  property  account  at  the  convertible  figure.  In 
these  circumstances,  it  would  seem  that  charging  interest  as 
well  on  the  amount  invested  would  -be  making  a  double  charge." 
W.  B.  Richards  in  the  Journal  of  Accountancy. 

'Show  that  Mr.  Richards'  contention  in  the  above  paragraph 
is  quite  unsound. 

44 

"Ricardo's  explanation  of  agricultural  rent  only  explains  it 
as  a  gross  return  to  the  land,  not  as  a  net  income  to  the  owner." 
Explain  fully  what  is  meant. 

45 

Look  up  Professor  Fetter's  idea  of  the  relation  between  rent 
and  interest. 

46 

"The  law  of  diminishing  returns  is  at  once  a  cause  of  rent 
and  a  check  upon  rent."  Explain  how  this  is  possible. 

47 

"The  principle  that  price  must  in  the  long  run  equal  the 
cost  of  production  is  only  a  part  of  the  process  whereby  price 

465 


PRINCIPLES  OF  ECONOMICS 

is    made   to   express    the   marginal    utility   of    our   primary    cost 
goods."     Explain  how  this  can  be. 

48 

"If  there  were  no  cost  of  production,  we  could  produce  as 
many  of  the  objects  as  we  please  with  no  sacrifice  of  any  kind; 
so  that  we  could  satisfy  all  our  wants  down  to  zero.  In  that 
case,  there  would  be  no  marginal  utility  in  things  and,  there- 
fore, no  value."  •  From  a  student's  paper. 

Show  that  the  student  quoted  rather  over-stated  things. 

49 

"The  economic  forces  have  no  tendency  whatever  to  direct 
my  effort  to  the  most  widely  important  end  or  the  supply  of  the 
most  urgent  individual  need."  Wicksteed,  page  189. 

Argue  that  Wicksteed  very  much  over-stated  this  case. 

50 

"Labor  is  found  often  to  detemine  value,  but  only  in  an  indi- 
rect manner^  by  varying  the  degree  of  utility  of  the  commodity 
through  an  increase  or  limitation  of  supply."  Jevous  Theory  of 
Political  Economy,  page  2. 

'Show  that  it  is  perfectly  possible  theoretically  that  a  change 
in  the  cost  of  production  should  change  the  price  without  chang- 
ing the  marginal  utility. 

51 

Explain  what  we  mean  by  the  naive  or  popular  productivity 
theory  of  interest. 

Show  that  this  theory  involves  reasoning  in  a  circle. 

52 

Define  and  distinguish  explicit  and  implicit  interest.  Give 
illustrations  of  the  chief  sorts  of  implicit  interest. 

53 

Give  the  dilemma  by  which  Boehm-Bawerk  tries  to  show 
that  there  can  be  no  productivity  explanation  of  interest. 

Show  that  neither  horn  of  the  dilemma  is  in  the  least  degree 
dangerous. 

Show  that  the  dilemma  is  merely  useful  in  isolating  the  real 
problem  to  be  solved. 

54 

W'hy  do  we  describe  Carver's  explanation  of  interest  as  a 
cost-productivity  theory  ? 


One  writer  thinks  that  Carver  in  order  to  make  his  explana- 
tion complete  needs  to  go  on  to  meet  the  English  horn  of 
Boehm's  dilemma.  Show  that  the  explanation  made  by  Carver 

466 


MISCELLANEOUS  PROBLEMS 

has   already   completely   met   the    dilemma   of    Boehm;    or   any- 
how has  demolished  the  English  horn  of  that  dilemma. 

Show  that  on  pages  245  to  249  Carver  demolishes  the  Aus- 
trian horn  of  Doehm's  dilemma. 

56 

Starting  with  the  data  given  in  problem  2,  page  369,  perform 
the  following  problems  : 

(a)  Show  that  if  the  owner  of  the  net  and  the  fisherman 
each  get  1500  of  the  3000  fish  caught  there  would  be  no  interest. 

(ib)  Show  that  if  the  fish  were  divided  in  such  way  that 
1700  went  to  the  owner  of  the  net  and  1300  to  the  fisherman, 
there  would  necessarily  be  interest. 

(c)  Explain  what  condition  would  ibring  about  a  bargain 
of  this  sort  between  the  owner  of  the  net  and  the  fisherman 
who  borrowed  it. 

(d-)  Show  that  when  you  have  accomplished  the  task  last 
set,  you  have  already  met  the  difficulties  presented  by  Boehm- 
Bawerk's  dilemma. 

57 

''Labor  is  found  often  to  determine  value,  but  only  in  an 
indirect  manner,  by  varying  the  degree  of  utility  of  the  com- 
modity through  an  increase  or  limitation  of  the  supply."  Jevons' 
Theory  of  Political  Economy,  page  2. 

Show  that  it  is  perfectly  possible  theoretically  that  a  change 
in  the  cost  of  production  should  change  the  price  without  chang- 
ing the  marginal  utility. 


APPENDIX  II. 
EXPLANATORY  NOTES, 


As  indicated  on  page  39  we  continue  in  this  text  the  con- 
ventional distinction  between  land  and  capital.  A  full  discussion 
of  the  reasons  for  this  decision  would  be  out  of  place  in 
Course  1.  Further,  the  strongest  reason,  viz.,  that  land  and 
capital  behave  differently  in  respect  to  value-determination,  can 
be  appreciated  only  when  we  have  considered  the  latter  subject. 
There  is,  however,  one  objection  to  the  orthodox  position  hav- 
ing considerable  vogue  in  our  day  to  which  we  will  give  a  mo- 
ment's attention.  As  the  student  will  remember,  the  orthodox 
analysis  makes  producibleness  the  line  of  demarcation :  land  is 
of  natural  origin,  capital  is  a  product.  Now,  to  this  distinction 
it  is  objected  that  real  land,  land  as  we  know  it,  is  producible 
just  as  truly  as  capital.  It  is,  of  course,  true,  they  say,  that  the 
amount  of  land  is  unchanging,  but  the  economic  supply  is  con- 
stantly altered  by  man.  Now,  it  would  be  quite  inconsistent  for 
us  to  deny  that  our  critics  have  a  perfect  right  to  use  "produc- 
ible," "amount,"  and  "economic  supply"  in  these  senses,  if  they 
think  best.  All  analysis  and  definition  is  more  or  less  inade- 
quate and  illogical.  But  we  can,  I  think,  rightly  object  to  their 
employing  these  meanings  to  prove  that  land  is  producible  in 
our  sense.  As  we  use  the  terms,  "economic  supply"* 
is  not  broader  than  "amount,"  but  narrower.  If  I 
can  not  first  add  to.  the  amount  of  anything,  I  can  not 
add  to  the  supply  of  it;  though  I  can  add  to  the  amount  with- 
out adding  to  the  supply.  The  natural  explanation  of  the  lan- 
guage cited  would  seem  to  be  that  the  writer  has  made  a  false 
antithesis  by  joining  the  first  member  of  one  antithesis  with  the 
second  member  of  another.  In  every  producing  combination, 
there  is  an  unproducible  something,  the  amount  of  which  is 
properly  contrasted1  with  the  economic  supply  of  it.  There  is 
also  a  producible  something  the  amount  of  which  is  properly 

'Save,  perhaps,  in  the  case  of  the  fictitious  supply  of  option  trading. 


NOTES 

contrasted  with  its  economic  supply.  But  we  have  no  business 
to  put  the  amount  of  the  unproducible  something  into  antithesis 
with  the  supply  of  the  producible  something.  When  I  put  on 
the  market  a  field  that  is  cleared  of  stones,  drained,  and  lev- 
eled, I  am  adding  to  the  economic  supply  of  prepared  land.  But, 
unless  I  or  some  one  else  had  already  added  to  the  amount  of 
prepared  land,  I  could  not  have  added  to  the  supply 
of  it.  In  fact  all  this  sort  of  thing  seems  to  confuse 
the  using  of  object  A  in  order  to  produce  object  B  with  the 
producing  of  object  A.  The  man  who  takes  flour,  out  of  this 
flour  makes  bread,  and  puts  this  bread  on  the  market,  is  not 
only  not  adding  to  the  amount  of  Hour,  he  is  also  not  adding  to 
the  economic  supply  of  -flour.  He  is  adding  to  the  amount  of 
bread  and  he  is  adding  to  the  supply  of  bread. 

Note  to  Page  99. 

In  the  series  of  imaginary  experiments  just  analyzed,  Factor 
B  was  increased  with  each  experiment.  It  is  obvious  that,  if 
the  results  of  said  increases  are  as  indicated,  decreases  would  be 
followed  by  opposite  results;  that  is,  we  can  read  our  table  up 
as  well  as  down.  So  read,  it  gives  the  following  result :  If  we 
start  with  one  of  the  factors  in  great  excess  and  diminish  that 
factor  in  successive  experiments,  the  results  will  break  into  three 
stages  as  before:  (1)  output  increasing;  (2)  output  diminish- 
ing but  less  than  proportionately;  and  (3)  output  diminishing 
more  than  proportionately.  This  way  of  looking  at  the  matter 
is  important  as  furnishing  an  additional  test  as  to  the  stage  in 
which  a  factor  or  an  industry  is  to  be  found. 

Note  to  Page  105. 

On  page  104  it  was  explained  that  a  table  reversing  the  rules 
of  As  and  Bs  was  directly  deducible  from  Table  I  given  on  page 
96.  The  following  discussion  shows  how  this  is  accomplished. 
First,  the  averages  given  in  Columns  VII  and  VIII  would  of 
course  result  from  all  combinations  showing  the  same  ratios  of  A 
and  B,  whatever  the  total  of  said  combinations.  Thus,  Combina- 
tion 5 — 20  As  to  6  Bs — gives  a  B  average  of  14  and  an  A 
average  of  4.2;  and  the  result  would  be  the  same,  if  the  combina- 
tion were  100  to  30  or  40  to  12  or  30  to  9  or  any  other  embodying 
a  ratio  of  10  to  3.  We  can,  therefore,  make  a  table  showing  just 
the  same  averages  for  each  combination  by  diminishing  As 

469 


PRINCIPLES  OF  ECONOMICS 

rather  than  increasing  Bs,  provided,  of  course,  we  reproduce  the 
same  combining  ratios.  Secondly,  we  can  compute  froim  these 
averages  the  total  output  from  each  combination.  Thirdly,  we 
can  begin  at  the  bottom  of  this  table,  thus  making  A  an  increas- 
ing factor,  and  compute  proportional  and  actual  increases  in 
product  just  as  in  our  first  table.  Carrying  out  this  plan  gives 
us  Table  II. 


TABLE  II.* 


I 

II 

III 

IV 

V 

VI- 

VII 

VIII 

IX* 

vf 

§ 

"s 

s 

£§ 

<^i 
*5 

1^ 

1^ 

i* 

.8  tj 

o'V) 

1^ 

|a 

I   f 

g  b 

*—   ^s. 

vS  S 

^•H 

&45 

^J*i 

s 

^ 

^ 

O 

0,4 

^ 

^  fX,  o 

I 

200 

20 

20 

20 

—  20 

.1 

: 

*j 

2 

133-3 

20 

40 

26 

—  40 

•  3 

2 

1 

3 

100 

20 

80 

35 

—  00 

.8 

4 

—3 

4 

80 

20 

140 

56 

—  140 

1-7 

7 

—6 

5 

66.6 

20 

280 

60 

—  80 

4.2 

14 

—8 

6 

57-1 

20 

360 

56 

—  33 

6.3 

18 

—4 

7 

50 

2O 

390 

So 

—  5 

7-8 

19.6 

—  i 

8 

44-4 

20 

397 

44 

2 

8.9 

19.9 

—  -5 

9 

40 

20 

400 

79 

7 

10 

20 

i 

10 

33-3 

2O 

393 

63 

13 

ii.  8 

19.6 

2.6 

ii 

28.5 

20 

3'8o 

58 

18 

13-3 

19 

5 

12 

25 

20 

362 

43 

16 

14-5 

18.1 

5-7 

13 

22.2 

2O 

346 

36 

16 

15-6 

17-3 

7-2 

14 

20 

20 

330 

34 

18 

16.5 

16.5 

9 

15 

18 

20 

312 

36 

22 

17.3 

15-6 

ii 

16 

16 

2O 

290 

38 

24 

18.1 

14-5 

12 

17 

14 

20 

266 

39 

30 

19 

T3.3 

15 

18 

12 

2O 

236 

40 

36 

19.7 

ii.  8 

18 

19 

IO 

2O 

200 

19.8 

21 

20 

10 

21 

20 

9 

2O 

179 

19-5 

23 

19.8 

8-9 

23 

21 

8 

2O 

156 

18 

30 

19-5 

7-8 

30 

22 

7 

20 

126 

14 

42 

6.3 

42 

23 

6 

20 

84 

7 

49 

14 

4.2 

49 

24 

5 

20 

35 

4 

19 

7 

1-7 

19 

25 

4 

20 

16 

2 

10 

4 

.8 

10 

26 

3 

20 

6 

I 

4 

2 

•  3 

4 

27 

2 

20 

2 

I 

.1 

I 

*The  first  table  was  constructed  symmetrically  in  respect  to  A  and  B;  so 
that,  in  making  the  second  table,  literal  computation  is  unnecessary. 

470 


NOTES 

In  this  table  we  start  with  200  As  and  20  Bs,  a  combination 
which  embodies  the  same  combining  ratio  as  Combination  1  of 
our  first  table,  and  diminish  the  As  each  time  just  enough  to 
reproduce  exactly  the  ratio  of  the  corresponding  combination 
in  our  first  table.  This  will  of  course  make  our  averages  for 
Columns  VII  and  VIII  the  same  as  in  the  first  table.  We  then 
compute*  output  totals  for  Column  IV  by  multiplying  Ihe  B 
average  of  each  combination  by  20.  We  then  compute  propor- 
tional and  actual  increases,  beginning  at  the  bottom,  for  Columns 
V  and  VI.  Finally,  the  marginal  products  for  A's  are  computed 
from  the  bottom  upwards  and  entered  in  Column  IX. 

Reading  this  table  upwards,  we  obviously  have  an  exact 
analogue  of  Table  I,  f.  e.,  we  have  a  table  in  which  one  of  the 
factors  (B  this  time)  remains  constant  while  the  other,  A,  in- 
creases. The  results  are  of  course  the  same  also.  From  Com- 
bination 27  up  to  19,  output  increases  more  than  proportionately 
to  the  increase  of  A;  from  18  to  9,  it  increases  less  than  pro- 
portionately; from  8  to  1  it  decreases.  When  averages  are  fol- 
lowed, also,  the  results  are  the  same  as  in  our  first  table.  That 
is,  from  27  back  to  19,  the  average,  measured  in  either  factor, 
increases ;  from  18  to  9,  as  measured  in  B,  it  increases,  but,  as 
measured  in  A,  it  diminishes;  from  8  to  1,  it  diminishes,  meas- 
ured in  either  factor.  It  is  thus  evident  that,  if  the  combina- 
tions behave  as  supposed  when  A  remains  constant  while  B  in- 
creases, they  will  necessarily  behave  in  similar  fashion  when  B 
remains  constant  while  A  increases.  In  short,  anything  which 
we  can  affirm  about  A,  in  the  first  series,  can  be  equally  affirmed 
about  B  in  the  second ;  while  anything  we  can  affirm  about  B  in 
the  first  series  can  equally  be  affirmed  about  A  in  the  second. 

It  follows  from  what  has  just  been  said  that  every  particular 
combination  in  Table  I  wherein  A  is  constant  and  B  increasing, 
appears  in  another  guise  in  Table  II,  wherein  B  is  constant  and 
A  increasing;  and,  in  consequence,  we  have  a  new  choice  of 
ways  for  expressing  some  of  the  most  important  cases.  If  we 
wish  to  describe  a  given  combination  from  the  A  standpoint, 
we  can  treat  it  as  a  combination  in  which  A  is  the  constant 
factor  or  as  one  in  which  A  is  the  increasing  factor.  Thus,  if 
we  know  that  A,  as  the  constant  factor  in  an  A-B  series  of 
combinations,  has  reached  the  point  of  maximum  efficiency, — 
Combination  9, — we  can  express  the  fact  in  this  way,  or  we  can1 

*Read  upwards. 

471 


PRINCIPLES  OF  ECONOMICS 

say,  instead,  that  A,  as  the  increasing  factor  in  a  B-A  combina- 
tion, has  reached  the  point  of  minimum  productivity; — we  could 
not  increase  the  proportion  of  A  without  diminishing  the  total, 
we  have  no  opportunity  to  utilize  any  more  of  it. 

Note  for  Page  196. 

It  is  perhaps  desirable  to  warn  the  student  against  a  mis- 
taken view  which  seems  to  have  been  held  by  more  than  one 
writer,  viz.  that  excess  of  demand  at  the  going  price  of  itself 
tends  to  lift  that  price  to  a  higher  figure,  and  that  excess  of 
supply  at  the  going  price  of  itself  tends  to  pull  said  price  down 
to  a  lower  figure.  If  price  is  to  be  lifted  to  the  56c  point 
at  all,  the  s6c  demand  must  do  the  work;  for  it  is  plain  that  a 
55c  demand  would  never  have  any  tendency  to  lift  the  price 
above  55c.  On  the  other  hand,  if  price  is  pulled  down  to  540, 
the  54c  supply  must  do  the  work;  for  it  is  plain  that  a  550 
supply  could  never  bid  price  lower  than  550.  The  truth  of  this 
will  be  evident  if  we  remind  ourselves  of  the  reasons  why,  in 
our  original  case, price  had  to  be  just  55c — could  not  stay  at  54c 
nor  at  s6c.  It  could  not  stay  at  54c  because  55c  'buyers  would  bid 
it  above  that  figure  both  to  bring  out  the  marginal  increment  of 
supply  and  to  exclude  the  first  extra-marginal  increment  of  de- 
mand. But,  obviously,  this  upward  pull  of  the  55c  'buyers  would 
cease  when  actual  price  -had  reached  their  figure;  for  they  want 
the  goods  only  on  condition  that  the  price  is  as  low  ,as  55c.  If, 
then,  actual  price  is  to  be  lifted  above  55c,  this  must  be  done  by 
buyers  who  were  ready  to  purchase  at  56c  or  some  higher  figure. 
Turning,  now,  to  the  other  side  of  the  case,  we  remember  that 
the  reason  why  the  price  could  not  stop  at  56c  or  some  higher 
figure  was  that  the  55c  sellers  needed  to  bid  it  down  in  order  to 
retain  the  55c  increment  of  supply.  But,  obviously,  this  downward 
pull  of  the  5Sc  sellers  would  cease  when  price  had  reached  their 
figure :  since  their  selling  was  conditioned  on  price  being  as  high 
as  55c.  If,  then,  actual  price  is  to  be  pulled  down  to  54c  or  some 
lower  figure,  this  must  be  done  by  sellers  who  are  ready  to  dis- 
pose of  their  wares  at  5  cents  or  some  lower  figure.  It  is  plain, 
therefore,  that  excess  of  demand  at  55c  does  not  of  itself  tend  to 
pull  price  above  that  figure,  and  that  excess  of  supply  at  55c  does 
not  of  itself  tend  to  pull  price  below  that  figure. 

As  in  some  degree  a  qualification  of  the  above,  it  should  be 
remarked  that,  while  excess  of  demand  at  S5c  does  not  of  itself 

472 


NOTES 

tend  to  lift  price  to  any  higher  figure,  it  does  constitute  a  reason 
why  s6c  buyers  should  temporarily  bid  price  up  to  their  figure 
in  order  to  exclude  550  buyers  and,  so,  insure  getting  their  de- 
mand supplied.  In  like  manner,  while  excess  of  supply  at  55c 
does  not  of  itself  tend  to  pull  price  down  to  any  lower  figure,  it 
does  contsitute  a  reason  why  54c  sellers  should  temporarily  bid 
price  down  to  their  figure  in  order  to  exclude  550  sellers,  and,  so, 
insure  getting  rid  of  their  stock.  Accordingly,  excess  of  either 
demand  or  supply  at  actual  price  tends  to  make  such  actual  price 
more  or  less  unstable,  though  neither  of  itself  tends  to  move  act- 
ual price  from  where  it  is. 

Note  to  Page  288. 

To  start  with,  we  must  be  clear  as  to  the  exact  nature  of 
our  problem.  And,  first,  it  is  not  to  ascertain  the  technical  con- 
tribution of  each  factor.  For  example,  when  charcoal,  sulphur, 
and  saltpeter  are  combined  by  a  Crusoe  to  make  gunpowder,  and 
we  ask  how  much  does  each  contribute  to  the  result,  we  do  not 
mean:  How  necessary  is  each  chemically?  for,  of  course,  each, 
in  being  necessary  at  all,  is  as  necessary  as  every  other. 

In  contrast  the  problem  is  to  ascertain  the  economic  contri- 
bution of  each  factor, — its  significance  economically  considered. 
Thus,  suppose  Crusoe's  stocks  of  charcoal  and  sulphur  unlimited, 
but  that  of  saltpeter  so  small  that  he  must  restrict  quite  carefully 
its  use  in  making  powder, — keeping  his  output  of  the  latter  at  a 
figure  which  makes  the  marginal  utility  and  value  of  one  pound 
just  90  cents.  Supposing  his  labor  negligible,  what  utility  or 
value  will  he  impute  respectively  to  the  charcoal,  the  sulphur, 
and  the  saltpeter  necessary  to  produce  a  pound  of  powder? 
Answer:  to  charcoal,  zero  utility  or  value;  to  sulphur,  zero  util- 
ity or  value ;  to  saltpeter  90  cents  of  utility  or  value.  He  will 
set  as  much  store  by  every  .76  of  a  pound  of  saltpeter  as  by 
1  pound  of  powder;  because  having  the  powder  depends  on  hav- 
ing that  .76  of  a  pound  of  saltpeter.  He  will  not  set  any  store 
by  every  .11  of  a  pound  of  charcoal  or  .13  of  a  pound  of  sul- 
phur, because  having  particular  portions  of  either  of  these  is  not 
at  all  necessary  to  having  the  powder.  Chemically,  the  powder, — 
under  the  hypothesis  laid  down, — is  produced  out  of  the  char- 
coal, sulphur,  and  saltpeter  put  into  it.  Economically,  it  is  pro- 
duced from  saltpeter  only. 


473 


APPENDIX  III. 
Variations  of  Cases  Discussed  on  Pages  213-218. 

Case   la. 

A  slight  modification  of  our  last  hypothesis  gives  us  what 
we  will  call  Case  la.  In  this  we  suppose,  as  before,  that  supply 
remains  constant  throughout  a  considerable  series  of  prices, 
but  we  change  the  hypothesis  by  making  demand  also  constant, 
though  for  a.  shorter  series  of  prices  within  the  supply  series. 

This  is  illustrated  in  Figure 

Demand  Price  Supply      28,  in  which  supply  remains 

ooo  02  cents  ooo  02      constant    from   51    cents    to 

59   cents,    and    demand    re- 

90  60  130          mains     constant     from     57 

100  59  120          cents  to  53  cents.  Here,  price 

no  58  120          can  range  from  53  cents  to 

120  57  120          57    cents    only.      It    cannot 

120  56  120          go  above  57  cents,  because 

120  55  120          it   must  be   as   low   as   this 

120  54  120          in   order   to   bring   out   the 

120  53  120          marginal    increment    of    de- 

130  '52  120          mand, — in   other   words   be- 

140  51  120          cause  57  cents  is  the  mar- 

150  50  no          inal  demand  price.     On  the 

other     hand,     actual     price 

cannot  go  below  53  cents,  because  it  cannot  go  down  to  the  next 
lower  price,  52  cents,  since  this  would  let  in  too  much  demand; 
in  other  words,  it  cannot  go  below  53  cents  because  it  would 
then  get  as  low  as  the  first  extra-marginal  demand  price.  In  the 
case  before  us,  then,  actual  price  can  range  from  the  marginal 
demand  price  down  to,  but  not  including,  the  first  extra-marginal 
demand  price.  Formulating  this,  we  have  the  following : 

Principle.  //  the  supply  schedule  of  any  commodity  remains 
constant  through  a  considerable  range  of  prices,  while  the  de- 
mand schedule  remains  constant  through  a  shorter  range  within 
that  of  the  constant  supply  schedule,  then  price  must  either 

474 


NOTES 

coincide   with   the   marginal   demand  price   or  with  some   price 
V  i          ^°          .  6P  .        .  ^° .        .'^°  . 


55 


1       J 

1 

L 

•   m. 

~*\^ 

-  1 

2 

lying  between   the  marginal  demand  price  and   the  first  extra- 
marginal  demand  price. 

Case  Ha. 

The  case  just  considered  supposed  demand  to  be  constant  but 
allowed  supply  to  vary  in  the  usual  way.  A  slight  modification 
of  this  gives  us  an  analogue  to  Case  la.  In  this  modification, 
supply  continues  to  be  of  the  typical  sort  when  compared  with 
the  demand  schedule,  but,  after  all,  does  not  strictly  adhere  to 
the  pattern: — it  remains  constant  through  a  series  of  prices, 

"T  .      .  4t°  .  .  .  8i°  .      .  S° .      S|^° 


55- 


JT 


though  the  series  is  so  short  that  it  is  altogether  inside  the  series- 
through  which  demand  remains  constant.    In  Figure  30,  we  have 


475 


PRINCIPLES  OF  ECONOMICS 

represented  such  a  schedule.    Demand  remains  constant  between 

510  and  59c;  supply  between 

Demand  Price  Supply      540  and  560.     In  this  case, 

ooo  oz.  cents  ooo  oz.      price  cannot  go  above  56c 

because  57c  would  let  in  the 

100  60  160          first  extra-marginal  supply. 

no  59  150          On    the    other   hand,    price 

120  58  140         cannot  go  below  54c,  since 

120  57  130          this    is    necessary    to    keep 

120  56  120          the    marginal    supply    from 

120  55  120          dropping  out.     That  is,  the 

120  54  120          upper  limit  is  fixed  by  the 

120  53  no          first   extra-marginal    supply 

120  52  loo          price,  while  the  lower  limit 

120  51  90          is  fixed  by  the  marginal  sup- 

130  50  80         ply  price.    Further,  the  de- 

mand   prices    which    might 

fix  the  limit  are  not  operative  in  this  case, — the  marginal  demand 
price  being  too  high,  5oc,  and  the  first  extra-marginal  demand 
price  being  too  low,  Sic.  Accordingly,  our  formula  for  this  case 
is  the  following : 

Principle:  //  the  schedule  of  any  commodity  shows  demand 
constant  through  a  considerable  series  of  prices,  while  supply  is 
constant  through  a  short  series  within  the  series  showing  constant 
demand,  and  if  the  equilibrium  price  is  found  within  this  series, 
then  actual  price  must  equal  the  marginal  supply  price  or  some 
price  above  said  marginal  supply  price,  but  not  as  high  as  the  first 
extra-marginal  supply  price. 


476 


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